While doing a risk review of a portfolio, I stumbled on a portfolio with 55 mutual fund schemes and 52 direct equity investments. When the investor asked me what was the risk, I said there was ‘concentration’ risk. I also told him he was running the risk of ‘over-diversification’ . He asked me to speak in English. So here it is:

I explained that when you have too much of your money in one or 2 companies it was concentration risk. This normally happens when people have been investing for long periods of time. Let us say you put Rs. 10,000 in Infosys in 1993. It was a small amount at that point in time, but now it has grown to Rs. 1 crore. However now if your broker calls you and asks you to buy NTPC you dare to buy only 1000 shares – Rs. 200,000 BECAUSE you are too scared to put more than that in one company! This happens because you may not consider yourself ‘deserving’ that Rs. 1 crore! It is psychological, but if your total portfolio is today worth say Rs. 1.2 crores, you have A HUGELY concentrated portfolio.

However the risk of ‘over diversification’ is when you spread yourself too thin – you put a small amount in too many funds and many companies.

This investor was thoroughly confused. He thought either there could be a concentration risk or ‘over-diversification’ risk. How could this co-exist?

Well out of his portfolio of 52 direct investments, the top 3 made up of 54% of the total corpus. Most of the other shares were between 0.07% to 7% of his portfolio. In fact about 35 shares were under 1% of the total portfolio. His mutual fund portfolio was a bigger mess – he had too may schemes. This does not help reduce risk. Almost all his finance lessons seem to have come from questionable sources.