Diversification and Concentration Risk
Peter McGahan
Monday 11th May, 2026.
DIVERSIFICATON is simply the act of not relying on one outcome. It spreads your money across different assets which behave differently, so when one part struggles, another can help steady the ship. Harry Markowitz, the economist who formalised this in the 1950s, called it the only free lunch in finance. That wasn’t marketing. It was maths.
If you combine investments which do not move in perfect sync, the overall ups and downs of the portfolio reduce. In plain English, you can take less risk without necessarily giving up return.
That is the theory. The reality is where people go wrong.
The biggest risk most investors take is not market risk. It is concentration risk. That is the risk of having too much exposure to one company, one sector, or one country without realising it.
Start with a handful of shares you “like”. Add a fund which invests in similar names. Focus on income and drift into the same high-yield sectors. Before long, half of your wealth depends on a small group of businesses doing well at the same time.
You feel diversified because you own several things.
You are not.
The evidence is quite clear on how much diversification you need.
A portfolio of 10 shares still carries a large amount of avoidable risk. Even 20 is often not enough to smooth things out properly. Most robust research suggests you need something closer to 40 or 50 holdings, spread across different industries, to remove the bulk of that company-specific risk.
Anything less and you are taking bets, whether you realise it or not.
Many investors believe buying a well-known index such as the FTSE 100 solves this problem. It helps, but it does not eliminate it. The UK market itself is heavily tilted towards a small number of large companies and sectors. Financials, energy and consumer staples dominate. A handful of names account for a large share of both the index value and the income it produces.
So, you can own 100 companies on paper but still be heavily reliant on a dozen of them in practice.
That is concentration risk in disguise.
We have seen the consequences of this more than once. When a single company fails, the damage can be immediate and permanent.
At the other end, we have seen entire income strategies wobble when dividends were cut across the market. Investors who relied heavily on UK equity income found both their capital and their income falling at the same time. Different investments, same underlying risk.
So how do you diversify properly?
Start by accepting that diversification is not about how many lines you have on a statement. It is about how those investments behave relative to each other.
A well-constructed portfolio spreads across asset classes such as shares, bonds and cash. It spreads across regions, not just the UK. It includes different types of companies, not just the high-yield names which look attractive today. It avoids letting any single position become so large it can materially damage the whole plan if it goes wrong.
There is a balance to strike. Over-diversification can dilute returns and make a portfolio harder to understand. Owning 80 funds which all do roughly the same thing is not clever. It is just expensive confusion. The aim is not to own everything. It is to avoid being overly exposed to any single thing. Warren Buffet would argue this point when saying diversification is for those who don’t know what they are doing. He meant that simply spreading across multiple funds will just thin out your returns. Diversify, but only so far.
Furthermore, watch for diversifying across funds which spread you into the same stocks and sectors. To reduce costs, some invest into passives like ETFs and hold an active managed fund as well. Meanwhile the two funds can often be concentrated in the same portfolios.
Think of it like building a team. You do not want 11 goalkeepers. You do not want 11 strikers. You want a mix which works together.
That is diversification done well.
If you look at your own investments and cannot clearly explain what drives each part, or you notice the same names, sectors or themes appearing again and again, pause. That is usually where concentration risk is hiding.
The solution is not complicated, but it does require honesty. Spread your risks sensibly. Keep positions in proportion. And remember that feeling diversified and being diversified are not the same thing.
I will be creating a guide to investing, so, if you would like a complimentary copy, please email info@wwfp.net. If you have a financial enquiry, please call 01872 222422.
Peter McGahan is the Chief Executive Officer of Independent Financial Adviser firm, Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.
