Herfindahl Index: Is Your Client’s Portfolio Really Diversified?
Owning 20 or 30 stocks does not necessarily mean that an investor has a diversified portfolio. What matters is how the money is distributed across those stocks.
The Herfindahl Index (HHI) helps measure this concentration.
A Simple Illustration
Consider an investor with a ₹1 crore equity portfolio:
| Stock | Investment | Portfolio Weight |
|---|---|---|
| Stock A | ₹40 lakh | 40% |
| Stock B | ₹25 lakh | 25% |
| Stock C | ₹15 lakh | 15% |
| Stock D | ₹10 lakh | 10% |
| Stock E | ₹10 lakh | 10% |
| Total | ₹1 crore | 100% |
The Herfindahl Index is calculated by squaring each portfolio weight and adding them:
HHI = 40² + 25² + 15² + 10² + 10² = 2,650
Now comes the interesting insight.
Effective Number of Stocks = 10,000 ÷ HHI
= 10,000 ÷ 2,650 = 3.77
So, while the investor owns 5 stocks, the concentration of the portfolio is equivalent to holding only about 3.8 equally weighted stocks.
What Should a Wealth Manager See?
The investor may believe, “I own five different companies, so I am diversified.”
The HHI tells a different story. 65% of the portfolio is concentrated in just two stocks, making portfolio outcomes disproportionately dependent on those positions.
This is why wealth managers should look beyond returns and number of holdings and examine the actual concentration of client portfolios.
At PMSInsights.in, our Portfolio Analysis uses the Herfindahl Index to provide an additional perspective on the concentration within an investor’s equity holdings.
Diversification is not simply how many stocks your client owns. It is how evenly—or unevenly—their wealth is distributed among them.