Concentration
Quick Answer
Concentration is the opposite of diversification: an outsized portion of a portfolio in a single security, sector, asset class, issuer, or geography. Common sources include employer stock overweight, inherited positions, and single-sector funds. Under FINRA Rule 2111 and Reg BI, the representative must identify concentration across the customer's overall portfolio, even for positions the representative did not recommend.
If diversification is the risk-reducing strategy, concentration is its mirror image. On Series 6, the exam tests the representative's duty to identify concentration across the customer's overall portfolio, even when the representative did not recommend the concentrated position.
What is concentration risk?
- Concentration: the opposite of diversification; an outsized portion of a portfolio (or account) in a single security, sector, asset class, issuer, or geography
- Concentration amplifies both upside potential and downside risk; the portfolio's performance becomes tied to a single position or theme
- A representative has a responsibility to identify concentration in the overall portfolio and discuss diversification strategies with the customer, even if the representative did not recommend the concentrated position
Think of it this way: Diversification is insurance against any one thing going wrong. Concentration is a bet that one thing will go right. Both are legitimate strategies, but the customer should understand which one they are actually running.
What are the common sources of concentration on Series 6?
| Source | Example | Discussion Point |
|---|---|---|
| Employer stock overweight | Customer holds 40% of portfolio in employer shares from the Employee Stock Purchase Plan (ESPP), stock options, and 401(k) match | Single-company risk (the Enron analogy); recommend diversifying into a broad equity mutual fund |
| Inherited or gifted position | Customer inherited a concentrated low-basis position; reluctant to sell due to capital gains | Tax consequence is real but does not eliminate concentration risk; discuss tax-aware unwind strategies |
| Sector fund as sole equity holding | Customer owns only a technology sector fund as their equity exposure | Sector risk; recommend adding a broad-market fund or switching to a diversified core |
| Single-fund retirement portfolio | Customer's only investment is one mutual fund | Evaluate whether the fund itself is diversified; target-date or balanced funds provide multi-asset exposure in one holding |
Exam Tip: Gotchas
- Employer stock overweight is the most-tested concentration source on Series 6. The customer sees it as familiar; the representative sees a single-company exposure layered on top of the customer's paycheck from the same employer.
- A single mutual fund can still be "diversified" in substance if the fund itself is a target-date or balanced fund. The question is whether the underlying holdings are spread, not how many fund tickets are on the statement.
The Representative's Role in Identifying Concentration
- Under FINRA Rule 2111 (suitability) and the Reg BI care obligation, a representative considering a recommendation must evaluate the recommendation's effect on the overall portfolio, not the new purchase in isolation
- A suitable stand-alone fund recommendation may be unsuitable if it deepens an existing concentration
- The reverse is also true: a marginal stand-alone product may be suitable if it reduces an existing concentration
- The analysis covers outside holdings the customer discloses (a 401(k) at the employer, old accounts at other firms)
Exam Tip: Gotchas
- A customer who already owns $300,000 in employer stock and asks to invest a $50,000 bonus in a same-sector fund is worsening concentration. Even if the sector fund is suitable on its own, the representative should flag the overall portfolio imbalance.
- Concentration risk affects the whole portfolio, not just the concentrated position. The representative must consider outside holdings the customer discloses when evaluating whether a recommendation deepens or reduces concentration.
- Tax cost is a factor, not a trump card. A customer reluctant to sell a low-basis concentrated position still carries the risk. The representative can discuss strategies (gifting, charitable remainder trusts, option hedges outside Series 6 scope, gradual unwind) but cannot ignore the concentration.