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By Holly SwanExecutive Director, Advisor Institute

An unforeseen market event—like what we witnessed with recent runs on U.S. regional banks colliding with a European banking crisis and the ensuing impacts on the global banking sector—can help you illustrate the risks of failing to diversify concentrated positions. Let's take a look at three biases that can lead to holding concentrated positions and questions you can ask clients to help reframe their mindsets on the topic of diversification.

  1. Overconfidence

Overconfidence is the irrational tendency to overestimate the probability of positive personal events—and underestimate the likelihood of negative events. This bias is particularly common among corporate executives, as they may feel the success of the company is directly tied to their involvements. Consider asking, "Would a significant downturn in the company's stock impact your overall wealth goals?"

  1. Status Quo Bias

Psychologists have found that investors have a pronounced status quo bias. That is, they feel more regret if they take an action and have a negative result than if they'd done nothing and had a similar negative outcome. Some clients may subconsciously resist diversification out of fear that it could result in a negative outcome. Consider asking: "If your concentrated position were cash, would you choose to buy the same position you currently hold?"

  1. Loss Aversion

Investors are naturally loss-averse. Thus, if their stock has fallen from a previous high, they may be unwilling to sell. This holds true even when investors are in the black overall on the investment. Consider asking: "Have you considered selling a portion of your concentrated holding to free up some cash for opportunistic purchases of other companies with favorable outlooks?"

Regardless of whether or not clients are less likely to meet their financial goals today than they were a few weeks ago, now is an opportune time to illustrate how unforeseen market forces can impact concentrated positions—and, ultimately, their overall wealth plan.

Bottom line: Concentrated positions can pose huge risks for clients and wreak havoc on their financial goals. Use this opportunity in the wake of banking sector turmoil to highlight those risks and move the diversification conversation forward.