Overconcentration: A Tempting but High Risk Investment Strategy

Putting all your eggs in one basket can be a great decision if you are transporting eggs, but the analogy is not favorable when it comes to investment.

Sometimes, fiduciaries and brokers, out of over-excitement about the potential of an investment, recommend it to all their clients. When this happens, they may end up over-concentrating your portfolio in the investment.

This might not be a problem if the stock is performing well, but it is risky because any loss from the investment can result in a total loss of your portfolio.

For example, if an investor’s portfolio is over-concentrated in fossil energy, their portfolio could rapidly lose money if something like climate policies mandates using renewable energy. Or investing too much in one company, an industry such as automobile, or even a country. Some failures to diversify include investing in only one type of security, such as common stocks, against mixing stocks and bonds.

Types of Concentration

Overconcentration does not necessarily equate to fraud, provided your fiduciary or broker informed you of the risk, but you instead went ahead with the investment.

To effectively manage concentration risk, FINRA explains five ways it might occur: 

  • Intentional Concentration: This is when a portfolio is concentrated in a stock with the prediction it would outperform others.
  • Concentration due to asset performance: You might notice a particular stock is outperforming others, and over time, its total worth might grow to over half of your total portfolio.
  • Concentration dues to company bias: As an employee of a firm, you may be tempted to concentrate your retirement savings in its stock.
  • Correlated assets concentration: Outstanding performance of a stock in your portfolio might entice you to invest more in similar stocks in the industry.
  • Concentration due to illiquid assets: Certain investments, such as non-traded real estate investment trusts (REITs), might be difficult to liquidate, hence occupying a large portion of an investor’s portfolio longer than preferred.

When Is Over Concentration Considered Fraud?

Fiduciaries are required to always prioritize your interest before their own. The FINRA Rule 2111 requires that a firm or associated person have a reasonable basis to believe a recommended transaction or investment strategy involving a security or securities suits the customer.

This means the firm must do due diligence on every and any stock before recommending it to its clients. The recommendation should consider the client’s age, net worth, and personal financial goals.

Most of the time, experts will advise against overconcentration, especially for clients that are close to retirement age. Losing their money at such an age could disrupt their retirement plan, and they would have been too old to start working for another savings.

Trust our investment loss attorney to fight for you

Since overconcentration is not an outright fraud, it is an allegation that can be difficult to prove. 

If you believe you or someone close to you has suffered financial loss due to overconcentration, consult an experienced stock fraud attorney today.

S.A. Law Group’s team of securities lawyers can help you decide if you have a case and what steps you should take to prepare for FINRA arbitration. Get in touch today for a free consultation or call us at (202)444-4222.

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