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Why is holding too much of my portfolio in a single stock risky?

Holding a significant amount of a portfolio in one or more individual stocks subjects the portfolio to the unique risks of that company. Sudden events such as the revelation of faulty products (Volkswagen), large-scale accidents (BP), or market dynamics like platform shifts and growth challenges (Groupon) can lead to sharp declines in individual stock prices, even in an otherwise rising market.

Modern Portfolio Theory, and specifically the Capital Asset Pricing Model (CAPM), asserts that this concentrated allocation is an uncompensated risk (i.e., it does not result in a higher expected return) and is therefore unnecessary. Research shows investors can minimize the company-specific risk of individual stocks by investing in 50 or more different issuers, provided the portfolio is not concentrated in any one of these stocks and each holding is relatively uncorrelated.

Nothing in this blog should be construed as tax advice, a solicitation or offer, or recommendation, to buy or sell any security. Financial advisory services are only provided to investors who become Wealthfront Inc. clients pursuant to a written agreement, which investors are urged to read carefully, that is available at www.wealthfront.com. All securities involve risk and may result in some loss. For more information please visit www.wealthfront.com or see our Full Disclosure. While the data Wealthfront uses from third parties is believed to be reliable, Wealthfront does not guarantee the accuracy of the information.

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