Some risks are unavoidable. Some can be eliminated through prudence and discipline. One type of risk, often called unique risk, represents the potential volatility that one company’s fortunes may bring to a portfolio. This can be reduced by diversifying – by holding many different securities.
We achieve unique risk reduction not just through limits on exposure to any one company but also through limits on sector exposure. It takes about 20 to 30 stocks to eliminate most of the volatility associated with individual firms, but if attention is not paid to industry concentration, harm from a single news item can still be devastating.
For smaller accounts, we might use low-expense index exchange traded funds to achieve diversified exposure to the market. Also, we may use sector and international exchange traded funds to gain diversified involvement in desirable sectors and countries.
Further, if a client has large exposure to a particular firm or industry which is not easily shed, perhaps for reasons of employment, tax avoidance, illiquidity, or personal preference, we can adjust other holdings to mitigate the risk therein.