What Makes Systematic Risk and Unsystematic Risk Different

What Makes Systematic Risk and Unsystematic Risk Different

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Syed Aquib Ur
Syed Aquib Ur Rahman
Assistant Manager
Updated on Aug 28, 2023 19:02 IST

The main difference between systematic risk and unsystematic risk is that systematic risk affects the entire market, while unsystematic risk is specific to a particular company or industry.

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Every investment has some degree of risk. Even when you invest in safe assets, there is a possibility to lose money. 

As an investor, it is critical to be aware of two types of risk. Systematic risk and unsystematic risk. We can help you understand their implications and further guide you on strategies to navigate them. Buckle up!

Explore the meaning of investing and its best practices.

Key Areas of Comparison Between Systematic Risk and Unsystematic Risk

Key Differences Systematic Risk Unsystematic Risk
What is it? Affects the whole economy or market. Specific to certain companies or industries.
Why it happens Comes from outside factors we can’t control. Comes from things happening in one company.
Examples Big economic changes, political events. Company problems like CEO changes.
Who’s affected All investments generally. Just certain companies or industries.
Fixing it Using strategies like hedging. Doing research and checking details.
Guessing it Hard to predict or see coming. Sometimes possible to predict or manage.
Market impact Linked to global news and trends. Linked to how one company is doing.
Up and down Can make all investments go up or down. Affects only the one company’s stock.

What is a Systematic Risk?

Systematic risk is the risk that affects the entire market. It is caused by factors that are beyond the control of any individual company or investor. 

Picture a sudden global economic downturn or a geopolitical crisis – events that can send shockwaves through financial markets. Other systematic risk examples include political instability, natural disasters, and changes in interest rates or inflation. 

Real-Life Examples of Systematic Risk

COVID-19 

The biggest and most recent example is the pandemic. COVID-19 swept across the globe. It’s not just about health. It’s about how this virus shook up economies, industries, and investments.

When COVID-19 hit, countries locked down, businesses closed, and people stayed home. This triggered a domino effect. Airlines grounded flights, factories shut down, and even the stock markets took a hit. This ripple effect is what systematic risk is all about – a single event creating waves that touch everything.

2007-2008 Financial Crisis 

This crisis saw the collapse of major financial institutions across the globe. Stock markets plunged, and even seemingly unrelated industries were hit. This underscores how systematic risk can sweep through the market like wildfire.

What is an Unsystematic Risk?

Unsystematic risks are specific to a particular company or industry. Some common examples include management changes, product recalls, or disruptive technological shifts. 

Common Scenario-Based Example of Unsystematic Risk

Suppose a pharmaceutical company faces a major lawsuit due to unexpected side effects of a newly developed drug. The broader market might be steady. But, this particular company’s stock could plummet due to the legal battle. This shows how unsystematic risk hones in on the vulnerabilities of a single entity.

Systematic Risk and Unsystematic Risk: Explaining the Differences

Take interest rate fluctuations: a change initiated by a central bank would impact the entire market (systematic). But, a specific company’s inability to manage its debt would be its unique burden (unsystematic).

How Systematic Risk and Unsystematic Risks are Measured

Analysts employ beta coefficients to measure systematic risk by gauging an investment’s sensitivity to overall market movements. 

Unsystematic risk is often assessed by carefully examining company financials, industry trends, and external factors.

To tackle this, diversification is a potent strategy in risk management

It’s all about spreading investments across various sectors and asset classes can help cushion against both systematic and unsystematic shocks. Additionally, hedging techniques like options and futures protect against potential downturns.

Navigating the Landscape of Systematic Risk and Unsystematic Risk

Investors tread a fine line between risk and reward. Systematic risk, while unavoidable, doesn’t have to be a nightmare. Being alert to global economic indicators and geopolitical events can aid in timely decision-making. 

For unsystematic risk, thorough research and due diligence are important. Analysing a company’s financial health, competitive landscape, and management practices can show potential red flags.

Maintaining a well-balanced portfolio is a cardinal rule. Diversification not only mitigates risk but also offers the potential for consistent returns. By spreading investments across industries and asset types, investors can avoid putting all their eggs in one volatile basket.

Influence on Investment Returns in Systematic Risks vs. Unsystematic Risks

How systematic and unsystematic risks work together in investing decides how investments do. Higher risk often correlates with the potential for higher rewards. But it’s a double-edged sword. 

Systematic risk might offer market-wide gains during economic upswings. But it can lead to significant losses during downturns.

In contrast, unsystematic risk magnifies the importance of due diligence. A company’s downfall can dent a portfolio, even in a bullish market. Balancing investments with a mix of risks becomes the investor’s strategic prerogative.

Additional Tips on Managing Systematic Risk and Unsystematic Risk

  • Understand how much risk you’re comfortable with. Think about your age, money goals, and how much risk you’re okay with.
  • Keep an eye on your investments. Sometimes, you’ll need to change things to match how much risk you want.
  • When the market goes down, don’t rush to sell. Selling then is usually a bad idea. Stay calm and wait it out.

Also, don’t forget to take up investing courses to improve your learning in related topics quickly!

About the Author
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Syed Aquib Ur Rahman
Assistant Manager

Aquib is a seasoned wordsmith, having penned countless blogs for Indian and international brands. These days, he's all about digital marketing and core management subjects - not to mention his unwavering commitment ... Read Full Bio