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Investing for US Expats - Concentrated Positions and Diversification

“My theory of risk is that it is better to take a substantial holding of what one believes in than scatter holdings in fields where one has not the same assurance.” - Allen C. Benello

Managing risk is a key consideration when investing, and all investors have their own perceptions and opinions as to how to approach and mitigate it. We’ve already covered some strategies to reduce risk in another article, and explained why higher risk is often equated with higher possible gains, and vice versa. In this article, we’re going to look at diversification, a common portfolio building strategy to reduce risk, and also the opposite strategy, taking a concentrated position, and the pros and cons of both.

In this article, specifically, you’ll learn about the following:

• What is a concentrated position?

• Pros and cons of holding a concentrated position

• What is portfolio diversification?

• Diversification strategies


Investing for US Expats - Concentrated Positions and Diversification

What is a concentrated position?


If a stock or asset makes up the majority or a sizable portion of an investor’s holdings, the stock or asset is said to have a concentrated position. Taking a concentrated position can affect the portfolio's overall returns and performance. Investors take concentrated positions in assets for a variety of reasons, including emotional considerations, stocks given as part of compensation, or due to strong convictions or a particular interest in a specific stock (or other asset).

A stock is typically considered concentrated (or ‘overweight’) if it makes up more than 10% of a portfolio. Similarly, a portfolio with a limited variety of securities is considered concentrated, as it does not offer sufficient diversity.

The main advantage of taking a concentrated position as an investment strategy is that if the single asset increases substantially in value, the investor benefits. Conversely, it’s also considered a high risk strategy because if the single asset experiences volatility, the whole portfolio suffers.

We will explore more pros and cons of taking a concentrated position in the next section.


Pros and cons of holding a concentrated position


Holding a concentrated position can be a double-edged sword, with both merits and downsides.


Pro of holding a concentrated position


There are cost savings associated with concentrated positions, as diversified portfolios tend to mean more regular trading. Furthermore, concentrated positions are often accumulated over the long term, and sales can be staggered to minimize capital gains taxes.

Often, if an investor decides to have a concentrated position, it should be a result of intensive research on the market, the sector and the company, in addition to constant monitoring to check if the investment thesis still holds. In other words, if an investor is very familiar with a company and really “knows what he/she is doing”, this could be an opportunity to achieve greater growth.


Cons of a concentrated position


A concentrated position however can suffer from unexpected downturns and volatility much more so than a diversified portfolio.

In a taxable brokerage account, selling concentrated positions built up over time can also trigger a large capital gains tax bill without expert advice and planning.


What is portfolio diversification?


Portfolio diversification is considered the opposite of holding concentrated positions. It means holding a range of small quantities of different types of assets, such as stocks from different industries and geographical areas, bonds, treasury bills, cash, sometimes real estate, and more. A diversified portfolio combines multiple asset classes and investment vehicles to reduce exposure to risk in any one area or sector.

Studies and simulations have demonstrated that the highest cost-effective level of risk reduction is achieved by maintaining a well-diversified portfolio of 25 to 30 different stocks.

Diversification reduces exposure to the ups and downs of companies, sectors, and markets by disseminating the risk in your portfolio.

Holding assets that perform inversely to stocks also allows those assets to be sold, and stocks to be progressively purchased during market (or sector, or company) downturns.

Because not all investments perform poorly at the same time, a broad portfolio is considered more stable than one that is concentrated.


Diversification strategies


Many of the strategies summarized below can be combined to increase the degree of diversification within a portfolio.

Many different asset classes are available when investing, including equities, investments with a fixed income, cash and its substitutes, tangible assets, such as real estate, and commodities.

You can build a diversified portfolio by including assets from various asset classes, because the risk and return characteristics of these asset classes normally vary. Typically, diversified investment portfolios include at least two asset groups.

Another diversification strategy is bond maturity duration. In general, the risk of price swings brought on by alterations in market interest rates increases with bond maturities. Although short-term bonds often have lower interest rates, they are also less susceptible to the unpredictability of future yield curves. As a result, more risk-averse investors can think about acquiring longer-term bonds, which often pay higher interest rates. Purchasing a mix of both balances the benefits and downsides of each.

Another strategy is to blend intangible assets like stocks and bonds with tangible assets such as real estate, farmland, hard assets like art or jewelry, and commodities. These capital investments have different characteristics compared with intangible or digital assets, since they can often be used, rented out, or developed, for example.

Geographical diversification is another diversification strategy that many investors utilize. This strategy is particularly suited to expats, as they may find it easier to invest in both the US and in their country of residence.

Or, you might invest in developed, developing and emerging regions. Always seek advice though to ensure you understand the risks involved.


Wrapping up


Investment decisions should always be underpinned by your risk tolerance and investment goals. While most investors look to diversify to reduce risk, there are circumstances where holding a concentrated position is a good strategy, and other times when it’s inevitable (such as when you’ve accumulated shares in a company you own or work for). If so, your expat financial advisor can let you know how best to move forward.


If you have any questions, don't hesitate to contact us.


DUNHILL FINANCIAL, LLC IS A REGISTERED INVESTMENT ADVISER. INFORMATION PRESENTED IS FOR EDUCATIONAL PURPOSES ONLY AND DOES NOT INTEND TO MAKE AN OFFER OR SOLICITATION FOR THE SALE OR PURCHASE OF ANY SPECIFIC SECURITIES, INVESTMENTS, OR INVESTMENT STRATEGIES. INVESTMENTS INVOLVE RISK AND UNLESS OTHERWISE STATED, ARE NOT GUARANTEED. BE SURE TO FIRST CONSULT WITH A QUALIFIED FINANCIAL ADVISER AND/OR TAX PROFESSIONAL BEFORE IMPLEMENTING ANY STRATEGY DISCUSSED HEREIN.


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