Concentration risk
What is it?
It is the risk associated with having a large portion of the investment or portfolio concentrated in a single asset, sector, or geographic region. Concentration risk occurs when an investor allocates a significant portion of their capital to a single element within their portfolio, which increases their exposure to factors that may negatively impact that specific asset or area.
For example, if an investor allocates most of their capital to a single sector, such as real estate or technology, any adverse event affecting that sector (such as an economic crisis, regulatory changes, or technological advancements) can have a disproportionate impact on the portfolio. Similarly, concentration in a single geographic region exposes the investor to risks related to local factors, such as political instability or natural disasters.
Key aspects to consider
Concentration risk is one of the main risks associated with the lack of diversification in an investment portfolio. A high concentration in a single asset, sector, or region can lead to significant losses if that asset or area faces challenges, while a broader and more diversified distribution can help mitigate this risk.
It is important for investors to understand that while concentration in a single asset or sector may offer high returns under certain circumstances, it also increases vulnerability to the specific risks associated with that asset or sector. Therefore, diversification is considered a key strategy to reduce concentration risk and spread risk more evenly across different asset classes, sectors, and geographies.
Investors should evaluate their financial objectives, risk tolerance, and time horizon to determine the appropriate degree of concentration or diversification in their portfolio.