Diversification & Concentration Risk
Plain English
Concentration risk means having too much riding on one thing (one stock, one employer, one property). Diversification means spreading that risk across many things that don't all move the same way at the same time.
What is it?
Concentration risk is the risk of having a large share of wealth tied to a single asset, company, or source (e.g. a large employer stock position, or a single rental property). Diversification is spreading investments across assets whose returns aren't perfectly correlated, so a decline in one is not necessarily mirrored by all the others.
Why does it matter?
Concentration risk is often invisible until it's realized — an employee holding a lot of employer stock is exposed to the same company for both their paycheck and their savings, so a single bad event can hit both at once.
How does it work?
Diversification works because assets with imperfect correlation don't all decline together — the mathematics of combining uncorrelated (or less-than-perfectly-correlated) assets can reduce a portfolio's overall volatility for a given expected return, though it does not guarantee a profit or eliminate the risk of loss.
Risks and limitations
Diversification does not eliminate market risk (a broad market decline still affects a diversified portfolio) and correlations between assets can increase during severe market stress, reducing the diversification benefit exactly when it may be needed most.
Questions to ask a professional
How concentrated am I in any single company, sector, or asset — including through my employer? Does my portfolio's diversification match my actual goals and time horizon?