Concentration Risk

Diversification spreads risk across many holdings, so that a problem in one has limited impact. Concentration risk arises when a portfolio or institution is heavily dependent on a few exposures.

For example, an employee who holds most of their savings in their employer's shares faces concentration risk. If the company runs into trouble, they could lose both their job and much of their savings at the same time.

Concentration risk applies to many situations: an investment portfolio dominated by one share or sector, a bank with large loans to a single borrower or industry, an insurer exposed to many properties in one area prone to hurricanes, or a business dependent on a few customers.

Some concentration may be intentional, since investors who hold fewer positions do so hoping for higher returns. But the potential for large losses should be understood and managed. Regulators limit concentration for banks and some funds, for example by capping exposure to any single counterparty.