How Portfolio Overlap Could Be Putting Your Investments at Risk!

While asset allocation and diversification don’t ensure a profit or guarantee against loss, investors often pursue diversification as a core risk management principle, spreading their capital across various funds and asset classes to reduce exposure to any single investment or asset class. However, for portfolios constructed using mutual funds or ETF’s, which have limited transparency, there’s a hidden risk lurking beneath the surface – portfolio overlap. This phenomenon occurs when an investor’s portfolio contains funds or investments that hold significant positions in the same underlying stocks, leading to concentrated exposure that diminishes the benefits of diversification. Understanding Portfolio Overlap Portfolio overlap is what occurs when multiple funds or investment vehicles in an investor’s portfolio share holdings. While an investor may believe they are spreading risk by investing in a mix of mutual funds, exchange-traded funds (ETFs), or separate stock portfolios, they may unknowingly be betting heavily on a handful of key stocks. This overlap not only undermines diversification but can amplify risk in ways investors might not anticipate. Consider an investor who holds a couple of large-cap mutual fund alongside a popular S&P 500 ETF.