A broker’s failure to diversify a customer’s portfolio may result in an excessive amount of risk to the customer without the corresponding potential for gain. This creates a situation beyond the customer’s appropriate tolerance for risk, and is also known as “concentrating” an account. Although diversification in itself does not guarantee profits or completely protect against loss, a diversified portfolio controls risk and helps to avoid potentially disastrous loss to the investor.

Because of the risks involved in over-concentration, last year, FINRA announced that it will increase its focus on the monitoring guidelines enlisted by brokerage firms to protect against over-concentration. FINRA cautions that brokerage firms should monitor for over-concentration of securities in the industry sector. Additionally, FINRA encourages firms to be attentive to shifts in interest rates. Attention to these issues prepares brokers to offer educated recommendations to their customers so that over-concentration is avoided.

Examples of over-concentration include having a very high percentage of invested assets in one or a few stocks, in one or a few sectors or industries, or in one or a few classes of assets. Over-concentration of an account is rarely suitable for an investor due to the excessive risk without the corresponding opportunity for gain. Unless an investor is specifically suited for such high risk and fully aware of how a concentrated account may affect the overall gain or loss in the account, a broker should never over-concentrate an investor’s account.

Other Examples of over-concentration include:

  • owning too much of one stock (employee stock options, company stock)
  • owning too many mutual funds in the same category (i.e., technology funds)
  • owning too many mutual funds in the same class (i.e. equity vs. fixed income)
  • owing too many mutual funds with the same objective (aggressive growth vs. Income)
  • owning too many mutual funds with the same core holdings
  • owning too many assets in the same asset class

There are ways to help manage your risk of over-concentration. First, frequently review your portfolio either on your own or with the assistance of your broker. You can diversify your major asset classes, such as stocks, bonds, CDs, and mutual funds. You can spread your stocks over various industries or sectors. Rebalancing your portfolio on a regular basis can guard against over-concentration.  Finally, learn about the liquidity of your investments so you can easily sell them if necessary. Over-concentration in a security may result in a lack of liquidity, making it difficult to sell.

While over-concentration is sometimes intentional and suitable for the investors, it can also be the result of fraud. Brokers have a duty to ensure that your investments are diversified based on your investment profile and your directions. Your investment profile includes your financial strategy, age, net worth, education, income, etc., and all these factors determine the types of investments appropriate, or suitable, for you. Your broker’s failure to diversify your portfolio according to your investment profile could cause devastating financial losses to you and your family.

The failure to diversify a concentrated portfolio, or the negligent recommendation of a concentrated portfolio, may be fraud or misconduct from which an investor is due a recovery of their losses. Claims against a broker for over-concentration are typically heard through FINRA’s arbitration process. You may also have a claim against your broker’s firm for its failure to supervise the broker. 

Where your investments over-concentrated? Call us at 903-597-2221 or contact us online.

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