The Concentration Risk Lurking in Your Portfolio

Peter, good to see you. I really like today's topic, the concentration risk lurking in your portfolio. A lot of investors have large positions in S&P 500 index funds or in mutual funds that use the S&P as a benchmark. So stocks, of course, are up quite a bit this year, which is good news for your portfolio. But most investors probably don't know that 80% of the gains we're seeing this year are due to only 10 stocks.

What's going on here? Yeah, well, those those FAANG and technology companies at about the worst year in 2022, but have rebounded this year, everything kind of being cyclical. If you look across all 500 rather than just those 10 companies of the S&P 500 stocks, most of them have not fared nearly as well this year, but they also did not lose nearly as much in 2022.

So we can't just look at a moment frozen in time of this year and say, oh, wow, we should be way, way up because a handful of stocks are. No, the weighting of the S&P 500, as you can see in this chart, is heavily within those monstrous companies. The FAANG stocks, Microsoft, Apple, Amazon, Google, Facebook, Netflix, Tesla. There's a few more than just the FAANG, but those 10 stocks have really led the way. Most people are not concentrated in just those 10 stocks, but a lot of mutual funds do include them. So where I see five or 10 mutual funds in a portfolio, we could take a look at that. And there may be a lot of overlap there, which means higher concentration in what could be very risky. And by the way, just because they've had a fantastic 2023, several of those stocks are not even back above where they ended 2021. So again, you can't look at just a moment frozen in time and say, well, I should be getting this performance. You've got to look over the history of that investment. Right. And I do want to bring up this little visual of the FAANG stocks because, Peter, of course, they make up a lot of those tech stocks that you're talking about.

And I want to ask as well. So again, we're putting this in perspective for everybody. We haven't seen this kind of concentration in 50 years since 1973. So what risk does this present? Well, by the way, I mean, if you are an aggressive or speculative investor, taking this risk may be appropriate. Most people are not aggressive or speculative, and so they are not all equity based like the S&P 500 or an S&P 500 index fund or mutual fund would be. That's equity based.

Most people are moderate, maybe moderately aggressive, maybe moderately conservative where you would mix in some bonds, bond funds and fixed income. So you wouldn't even get all of this return nor the volatility that we saw hopefully in 2022, although bonds and the traditional stability piece of fixed income had its worst year on record in 2022. And we don't have to go back 50 years to look at or experience over concentration, Aaron, because if we remember the tech bubble of the early 2000s, that was a time where the market over three years lost more than 50 percent on hold. But again, that was a time where one sector, just a handful, a concentration of companies sort of led the way.

And in that case, it was the way down. But many people and a lot of mutual funds were over concentrated in what was at that point in time, a very unproven tech sector. And when that bubble kind of burst, because those companies hadn't figured out how to be profitable back then, a lot of people lost a lot more money than they should have had they been properly diversified across multiple sectors or didn't at least have the concentration kind of all in one from a lot of the mutual funds that were chasing the fantastic returns that they had had leading up to that. So, again, it's cyclical. What goes up oftentimes comes back down or vice versa.

And everything sort of has evened out over time. When you see these fantastic run ups, a lot of times they are followed by kind of a run down or involve more volatility than a lot of people are comfortable with. Right. So let's talk through three strategies then to reduce that potential volatility. And first, you say seems kind of straightforward here.

Simply reduce your concentration. Yeah. Diversify, right? You should not put all your eggs in one basket. And if we are concentrated here in one sector or if multiple funds within your account have a high percentage that is exposed to that sector or those 10 companies, you are taking more risk than you may be aware of or then may be appropriate. And a proper diversification can serve to even things out, because there is another chart I like to look at, which is the top performing sector in the market year after year.

And guess what, Aaron? That top performing sector is never consistent. What is close to the top one year is close to the bottom a lot of times the next year. And it all sort of cycles through.

I like that visual too. Yeah. Second strategy would be hedged equities and buffered ETFs.

Yeah. There are ways that you can get a more predictable outcome or that you can protect against some of the downside or some of the losses. We're here in North Carolina, and I liken it to a hurricane that's spinning in the Atlantic off the coast. And they've got that spaghetti map where this storm could go all the way from the Gulf of Mexico up to New England. What we want to do for our financial future is reduce some of that delta and have a more known path or trajectory for where we are going to go. It would make things easier to predict. And if we can eliminate some of the highs and some of the lows, or if we can eliminate a good portion of the lows and have to give up a little bit of the highs to do so, most people are willing to do that, to have a little bit more certainty in their course moving forward. And the third strategy, structured notes.

Yeah. Structured notes, basically they come in a few different forms, but they are essentially a loan to a particular institution or institutions. A lot of times these are financial institutions. You get certain terms for your loan behind the scenes. They are making investments with your loan or playing options, but we leave that to the big brains at the financial institutions. They know that within a certain range of the market, they've got a particular outcome where they can offer you specific terms.

And again, it's about defining more of the outcome or reducing the volatility or the range of that outcome, giving us a smaller delta for where we are going to be in the future. So structured notes are really a asset class that a lot of people aren't familiar with and more should find out about that. A lot of times brokers, advisors, some of the other financial institutions that are more mutual fund brokerage shops don't have or do not utilize structured notes. And people should really find out about them because they do offer very attractive rates for principal protection in some cases, for income in other cases, or maybe the possibility for growth. And some of them can grow regardless of the direction up or down in the market within a range.

So that can be attractive as well. And I'll throw in a bonus here, Erin, is that I think that bonds and fixed income, they've had a rough go of things the last few years. Again, 2022, the worst year on record, but what goes down typically comes up and everything being cyclical. They are poised as the Fed begins to lower interest rates, or at least has peaked in their raising of rates.

So they say they have neared or aim to do into the near future. If those rates steady or begin to come down, bonds and traditional fixed income should benefit nicely. That could be a great position and opportunity play as well as interest rates right now. If you just want to remove the risk and look at just fixed interest bearing options, again, very attractive for specifically the more conservative, moderately conservative investor, or one that wants to balance the risk that they are taking with the equity exposure to find that balance of risk and safety.

The CDs at the bank, the high yield savings account, even some fixed annuities are offering very attractive rates, but rates could be coming down into the future as mentioned. So there is a pro and a con there for locking in these rates for a longer term period that could be considered and discussed. Lots of great information in here, Peter, if somebody has questions about anything that we've covered, what's the best way to reach you? Well, it is all very situational and specific to your individual set of circumstances and goals and time horizon where and how this would all be appropriate. But it is important that you understand these factors in your financial considerations. And if you'd like to look over optimizing your plan and finding the most appropriate investments to help you achieve your goals, give us a call.

That's what we do. We put together the optimized retirement plan, and you can reach us to request that 919-300-5886, 919-300-5886. You can email me, peter at rashaunplanning.com. Visit us online, rashaunplanning.com.

It looks like richonplanning.com. All right, Peter, thank you. Yeah, thank you. And thank you to all the clients who view these, tell me that they appreciate them. Leave comments, leave questions for us to discuss.

Hit that like button, that subscribe button, and share it with their friends. We really, really do appreciate that. Thank you very much. Yeah, thanks, Peter. Hi, everyone.

Peter Rashaun here. Hope you enjoy the content. As always, make sure that you like, subscribe, share the videos with others that may find this information helpful. And as always, you're welcome to be in touch or to submit questions or comments. You can comment below the video anything that you'd like to see or hear shared on our YouTube channel and in future videos. If you've got a topic that you've been thinking about or is of concern for you financially, be sure to let us know. We'd love to help you by discussing it on the channel. So appreciate the continued views and the likes and the subscribes, the shares, the comments, always helpful. We look forward to getting you the information that you need.

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