When Concentration Makes Sense

A student in my spring 2025 investments course told me, “I’m learning many useful things in your course, but none of them answer my main question.” He had recently moved to the Bay Area after a career in the Navy, found a job and enrolled in our MBA program.

He quickly learned that rent in our area would bite off a big chunk of his paycheck and that house prices were stratospheric, with price tags that looked as though they were quoted in yen. He despaired of buying a house in the Bay Area but aimed to buy one in Wisconsin or upstate New York, where his and his wife’s family lived. However, he had very little money — far less than he needed for a down payment in either place.

As he had learned in my course, a diversified portfolio of stocks and bonds could grow substantially — but over decades. He needed money for a down payment much sooner, so he chose a concentrated portfolio, such as one invested entirely in Bitcoin.

Some buyers of Bitcoin and other cryptocurrencies hope to be billionaires. Others, like my student, aspire to nothing more than making a down payment on a house, paying for a wedding or extinguishing student debt. They know that a portfolio concentrated in Bitcoin is riskier than a diversified portfolio of stocks and bonds, and subject to far larger price swings.

I empathize with my student. A diversified portfolio, such as a total U.S. stock market index fund, would have offered him virtually no chance of achieving his aspiration within his limited time frame.

By contrast, a concentrated portfolio invested entirely in Bitcoin would have offered him a chance, however small, to accumulate enough for a down payment, while exposing him to the risk of losing much of his limited wealth.

Two Ways to Think About Risk

I often observe, with obvious exaggeration, that we aspire to reach two goals in life: One is not to be poor, and the other is to be rich. This observation underlies behavioral portfolio theory.

Mean-variance investors view a portfolio as a whole, while behavioral investors see it as a layered pyramid. The bottom “not-poor” layer of the pyramid is intended to support essential financial needs, and the top “be-rich” layer is meant for more ambitious goals. These different perspectives lead to different definitions of risk. Mean-variance investors focus on return variability and generally prefer lower volatility. Behavioral investors focus on the possibility of failing to reach a goal. As a result, they may be willing to take on investments with more volatile returns if those investments offer a greater chance of achieving that goal.

Consider an investor with $1,000 who needs $10,000 for a down payment on a house. Anything less would not meet the goal. Suppose one investment offered a 20% chance of growing to $5,000, while another offered a 10% chance of reaching $10,000. Mean-variance portfolio theory would generally view the first investment as less risky because its returns are less variable.

Behavioral portfolio theory, however, would reach a different conclusion. Because $5,000 would still leave the investor short of the goal, the first investment would offer no chance of success. The second investment would offer only a 10% chance of success, but it would at least be capable of reaching the goal. In that sense, the first investment could be considered riskier because it is more likely to fail to meet the goal.

Think again about my student. Most of his not-poor layer consists of his human capital, his ability to earn income through work. He could put his limited savings toward that layer by keeping them in a savings account or investing in a diversified portfolio. Alternatively, he could put them toward his be-rich layer by investing in a concentrated Bitcoin portfolio. That choice would expose him to a greater risk of loss, but it would also offer at least some chance of reaching his down-payment goal, unlike a diversified portfolio, which would be unlikely to do so within his time frame.

The view of portfolios as layered pyramids is not only part of behavioral portfolio theory but also reflected in common investment guidance. One example is the “core and satellite” approach, which combines a diversified core intended to support essential financial goals with a more concentrated satellite designed to pursue aspirational goals.

When Concentration Works and When It Doesn’t

Consider older owners of established, profitable businesses whose portfolios are concentrated in those businesses. Their holdings may reflect be-rich aspirations. Their businesses may include car dealerships, franchises, agricultural companies and law firms. These investors’ concentrated portfolios aren’t a problem to solve if they also have substantial diversified investments to support their not-poor aspirations.

Next, consider relatively young engineers who own portfolios concentrated in technology ventures. These owners have chances of satisfying their be-rich aspirations even if their ventures do not grow into the likes of Apple, Google or Nvidia. Some ventures are fully funded by venture capitalists, leaving owners with possibly ample not-poor portfolio layers. Others are funded by owners who dip into their retirement savings, imperiling both the be-rich and not-poor layers of their portfolios. Yet even concentrated portfolios of the latter kind do not necessarily call for reduced concentration if the owners’ human capital is sufficient to replenish their not-poor layers through future employment if the ventures fail.

Concentrated portfolios can be problematic even by the rules of behavioral portfolio theory. This was the situation facing Elizabeth White, a 55-year-old woman who had retired from the World Bank. She invested a substantial portion of her retirement savings into a new retail venture, but the store soon failed.

Unlike my student, White lacked the human capital and years of future employment needed to replenish her not-poor portfolio layer. Investors in circumstances like White's may be better served by preserving the assets that support their not-poor aspirations and seeking other ways to satisfy their be-rich aspirations, perhaps even by buying the occasional lottery ticket.

Many investors with concentrated portfolios, even those with inadequate not-poor layers, are reluctant to sell because they cannot bear the possibility of future regret. Regret is the painful emotion we feel when we realize, in hindsight, that another choice would have led to a better outcome. In this case, it is the regret we feel when discovering that the investment we sold surged soon afterward.

Dollar-cost averaging, the practice of investing or selling in regular increments over time, is a method for reducing regret. Suppose you inherited $120,000 in stocks from a beloved uncle. You decided to sell them and keep the cash in the not-poor layer of your portfolio. You could sell the stocks today in a lump sum or sell them gradually in 12 equal $10,000 installments on the 15th of each month over the next year.

Think about the regret associated with selling all $120,000 of stocks today. How much regret would you feel if stock prices surged tomorrow? That regret would likely be lower if you sold only $10,000 today, because you could take comfort in the opportunity to sell the next $10,000 at a higher price.

The ‘Right’ Question About Concentration

Concentrated wealth portfolios are a problem by the rules of mean-variance portfolio theory, but they can be part of a solution by the rules of behavioral portfolio theory.¹

Concentration is not always an error. Instead, concentration can be a purposeful and sometimes necessary feature of portfolios constructed to serve human aspirations and goals. Behavioral portfolio theory reframes the diversification-versus-concentration debate. The question is not whether concentration is right or wrong in general, but whether it supports be-rich aspirations and goals without putting not-poor ones at risk.

That does not mean concentration is always wise. Its suitability depends on an investor's overall financial situation, especially the adequacy of the not-poor layer and the amount and quality of their human capital. Concentration may make sense for those with sufficient resources or earning power to replenish losses. It can be much more problematic for retirees, those heavily invested in employer stock or investors with limited ability to rebuild wealth after setbacks.

Sound planning balances the benefits of diversification with empathy for the aspirations and goals that lead clients to concentrate their portfolios. Seen through the lens of “not-poor” and “be-rich” aspirations, concentrated positions can be managed thoughtfully to support both financial security and the pursuit of meaningful goals.