Study Shows Risks of a Concentrated Stock Portfolio

Believers in holding concentrated portfolios may think a bit differently after reading J.P. Morgan’s report titled “The Agony and the Ecstasy: The risks and rewards of a concentrated stock position (hat tip to the Irrelevant Investor blog for highlighting the report) . According to the study, between 1980-2014, 40% of all stocks in the Russell 3000 index have fallen 70% where value was not subsequently recovered (what JP Morgan calls a “catastrophic loss”)  and over their full “lifetime” 66% of all individual securities actually underperform the benchmark.

The report shows that certain sectors, like technology and energy, have higher catastrophic loss rates vs. sectors like financials and consumer staples. While recessions tend to up the number of stocks exhibiting catastrophic losses, the data shows that firms also fail during expansionary times. This is a fascinating report that shows a very small percentage of stocks are huge winners, and most significantly underperform the benchmark over time (see the chart below). Catastrophic loss rates have appeared to be declining over the last few years, which could be in part a consequence of the Federal Reserve’s ultra-low interest rate policies.

The key takeaway according to JP Morgan is that “75% of all concentrated stockholders would have benefited from some amount of diversification.”