Concentration

Diversification and concentration are the same dial read from opposite ends. This chapter is about where to set it, and about the exposures already set for you.

The honest tension

Concentration is how large fortunes are built. Somebody who held one extraordinary business for twenty years did far better than a diversified investor, and this subject should not pretend otherwise.

It is also how they are lost, and the same decision produces both. The distinction is not whether the concentrated bet was brave. It is whether being wrong was survivable.

So the question is never "how confident am I?" — confidence is not evidence. It is: if this goes to zero, what is left?

The recovery arithmetic

Chapter 9 of the equity subject's point, applied to position sizing.

Loss	Gain needed to recover
20%	25%
50%	100%
80%	400%
90%	900%

The relationship is not symmetric, and it gets brutal quickly. A position that can take 80% off your portfolio does not need a second mistake to be permanent — recovering requires a quintupling of what is left.

This is why position size matters more than selection skill. A good process with ruinous sizing ends; a mediocre process with sensible sizing continues, and continuing is most of investing.

The concentration nobody counts

The most important paragraph in this chapter.

An employee holding their employer's shares has concentrated far more than the shares. Their salary depends on that company. Their bonus does. Their options do. Often the flat they bought is in the city the company's industry dominates.

Four exposures, one event. If the company fails, the shares fall, the income stops, the options are worthless and the local property market softens — simultaneously, and precisely when the emergency fund of chapter 4 is being drawn down.

Employee share schemes are genuinely valuable and this is not an argument against taking them. It is an argument for selling them down as they vest, because holding them is doubling an exposure you already have at maximum size and cannot diversify away.

The same applies to a business owner whose wealth, income and reputation sit in one entity, and to anyone whose savings are in the sector they work in.

Sizing a position

Three rules, in order of usefulness.

Size by what you can afford to lose, not by what you expect to make. Expected return is a guess; the loss is what happens if the guess is wrong.

Count correlated positions as one. Chapter 6. Three banks is one bet on banking.

Rebalance when a winner grows. A position that doubles is now twice the risk it was sized at. Letting winners run is how wealth is built; letting a winner become 60% of a portfolio is how it is lost. Trimming is not a lack of conviction — it is keeping the size you originally chose.

Where concentration can be defended

Not never, and the conditions are specific.

You genuinely understand it, in the sense of chapter 22 of the company analysis subject — you can write the page.

The downside is survivable at the size you have chosen, with the answer written down before you need it.

It is not correlated with your income. Which rules out the employer case entirely.

You can hold it through a 50% fall without selling, which is chapter 11's question about capacity rather than confidence.

Anyone meeting all four is in a different position from most concentrated holders, and the point of the list is that most people fail at least two.

The default

For almost everyone, the sensible setting is diversified — index funds, a bond allocation, and no single holding large enough that its failure changes the plan.

That is a dull answer, and the alternative has a measurable base rate. A diversified portfolio held for thirty years has a very high probability of a decent outcome. A concentrated one has a wider distribution with real mass at both ends, and only one of those ends is recoverable.

The point

Concentration builds and destroys wealth with the same decision, and the test is whether being wrong is survivable — the recovery arithmetic turns an 80% loss into a required 400% gain. The largest concentration most people hold is their employer, where shares, salary, bonus and local property are one exposure, which is why vested shares are usually worth selling down.