Systematic Risk vs. Unsystematic Risk

Attribute	Systematic Risk	Unsystematic Risk
Definition	Risk that is inherent to the entire market or economy	Risk that is specific to a particular company or industry
Also known as	Market risk	Specific risk
Caused by	Factors such as interest rates, inflation, and economic conditions	Factors such as company management, competition, and regulatory changes
Diversifiable?	No	Yes
Can be reduced through	Diversification	Company-specific strategies

Definition

Systematic risk, also known as market risk, is the risk inherent to the entire market or market segment. It cannot be diversified away through the use of a diversified portfolio. Unsystematic risk, on the other hand, is specific to a particular company or industry. It can be reduced through diversification.

Causes

Systematic risk is caused by factors that affect the overall market, such as interest rate changes, inflation, political instability, and natural disasters. These factors impact all investments in the market to some degree. Unsystematic risk, on the other hand, is caused by factors specific to a particular company or industry, such as labor strikes, management changes, or product recalls.

Diversification

Systematic risk cannot be eliminated through diversification because it is inherent to the market as a whole. However, investors can reduce their exposure to systematic risk by investing in a mix of assets across different markets and industries. Unsystematic risk, on the other hand, can be reduced through diversification. By spreading investments across different companies and industries, investors can minimize the impact of any one company's specific risks.

Impact on Returns

Systematic risk affects all investments in the market, so it has a broad impact on returns. When the market as a whole is performing poorly, most investments will also see a decline in value. Unsystematic risk, on the other hand, only affects specific companies or industries. If an investor's portfolio is well-diversified, the impact of unsystematic risk on returns can be minimized.

Measurement

Systematic risk is typically measured using beta, which compares the volatility of a particular investment to the overall market. A beta of 1 indicates that the investment moves in line with the market. A beta greater than 1 indicates that the investment is more volatile than the market, while a beta less than 1 indicates that the investment is less volatile. Unsystematic risk, on the other hand, is measured using standard deviation, which assesses the variability of returns for a specific investment.

Volatility

Systematic risk is often referred to as market risk because it is related to the overall market's volatility. Changes in market conditions, such as economic indicators or geopolitical events, can lead to fluctuations in the market as a whole. Unsystematic risk, on the other hand, is specific to individual companies or industries. It is not related to broader market conditions and can be mitigated through diversification.

Predictability

Systematic risk is difficult to predict because it is influenced by a wide range of factors that are often beyond an investor's control. Economic conditions, political events, and natural disasters can all impact the market in unpredictable ways. Unsystematic risk, on the other hand, is more predictable because it is specific to a particular company or industry. By conducting thorough research and analysis, investors can identify and mitigate unsystematic risks.

Long-Term vs. Short-Term

Systematic risk tends to have a greater impact on long-term investments because it is related to the overall market's performance over time. Economic cycles, inflation, and interest rate changes can all influence long-term investment returns. Unsystematic risk, on the other hand, is more likely to impact short-term investments. Company-specific events, such as earnings reports or product launches, can lead to short-term fluctuations in stock prices.

Conclusion

In conclusion, systematic risk and unsystematic risk are two important components of investment risk. Systematic risk is inherent to the market as a whole and cannot be diversified away, while unsystematic risk is specific to individual companies or industries and can be reduced through diversification. By understanding the differences between these two types of risk and how they impact investment returns, investors can make more informed decisions about their portfolios.