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  • The concentration risk in investing – THIS IS WHAT YOU NEED TO KNOW!
  • The concentration risk in investing – THIS IS WHAT YOU NEED TO KNOW!

The concentration risk in investing – THIS IS WHAT YOU NEED TO KNOW!

Concentration risk: what does it mean?

It is evident that investing involves risks . If you want to make a profit with various investment products , you must also accept the risks. With investment risk, we can distinguish different types of risks. In this blog, we will delve deeper into concentration risk. We will explain what it entails and how you can protect yourself against it.

The concept of concentration risk

In the world of investments, concentration risk refers to the risk that is created by investments that are too focused on one company, one industry in particular or one country. This means that there is too little diversity in your investment portfolio .

This investment risk can arise in different ways. Firstly, when you invest in one type of investment product , for example by choosing 100% shares . Secondly, there is a greater risk if you invest in only one or a few companies . Finally, you run a greater risk of a concentrated and one-sided portfolio by investing in only one specific region or sector .

Why is avoiding concentration risk so important?

The next question arises here: what dangers does this concentration risk entail? Are there more negative consequences associated with investing in one company and are there fewer when investing in 50 different companies?

That is certainly the case. It makes a big difference whether you invest in one company or more. To illustrate this, two practical examples follow.

Example

Let’s assume that you have invested your entire capital in the shares of just one company. If this company were to go bankrupt, you would lose all your money. In the situation where you were to divide your investment capital over three companies, you would lose only 1/3 of your invested money in the event of the bankruptcy of that one company. The greater the spread over a number of companies, the smaller the risk of loss becomes. With an investment in 25 different companies, you would then have lost only 4% of your investment.

Good to remember: the more diversification in your portfolio, the less risk of loss. Another important point is the diversification over different types of investments.

By investing only in stocks, you can be hit hard when the economic situation is less rosy or when companies are doing less well due to other circumstances such as inefficient management. In a recession, a sharper fall in stock prices compared to bond prices is more the rule than the exception.

If you choose to invest only in stocks, you will lose a large part of your capital. Have you chosen to invest in both stocks and bonds? No worries! Now the losses you have collected are largely compensated by the returns from the bonds in your portfolio.

This shows that diversification plays a very important role in investments. With good diversification you reduce the risk of significant losses.

How can you prevent it?

It is easy to prevent loss of concentration by investing in an efficient way and by ensuring the necessary balance in your investment portfolio. Realizing diversification for your investment portfolio is possible in various ways

The first option is to figure this out and arrange it yourself. As a guideline, you take a larger number of companies and make a variation in this by choosing companies from different regions and sectors. This method does take a lot of time and you also need to have a considerable amount of experience to set up a portfolio yourself.

Another option is to eliminate concentration risk by opting for an  investment fund . By buying shares in an investment fund, you invest in many different shares at once. Fund investing is therefore synonymous with a diversified way of investing.

Another similar option is to invest in an index fund or  ETF  (Exchange Traded Fund). These are funds that closely follow an index. Examples of these are the  AEX , the MSCI World Index or the S&P 500 Index. These indices include a large number of different types of shares, in which investments are made simultaneously.

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