Unsystematic Risk

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What is 'Unsystematic Risk'

Company- or industry-specific hazard that is inherent in each investment. Unsystematic risk, also known as “nonsystematic risk,” "specific risk," "diversifiable risk" or "residual risk," can be reduced through diversification. By owning stocks in different companies and in different industries, as well as by owning other types of securities such as Treasuries and municipal securities, investors will be less affected by an event or decision that has a strong impact on one company, industry or investment type. Examples of unsystematic risk include a new competitor, a regulatory change, a management change and a product recall.

BREAKING DOWN 'Unsystematic Risk'

For example, the risk that airline industry employees will go on strike, and airline stock prices will suffer as a result, is considered to be unsystematic risk. This risk primarily affects the airline industry, airline companies and the companies with whom the airlines do business. It does not affect the entire market system, so it is an “unsystematic” or “nonsystematic” risk.

An investor who owned nothing but airline stocks would face a high level of unsystematic risk. By diversifying his or her portfolio with unrelated holdings, such as health-care stocks and retail stocks, the investor would face less unsystematic risk. However, even a portfolio of well-diversified assets cannot escape all risk. It will still be exposed to systematic risk, which is the uncertainty that faces the market as a whole. Even staying out of the market completely will not take an investor’s risk down to zero, because he or she would still face risks such as losing money from inflation and not having enough assets to retire.

Investors may be aware of some potential sources of unsystematic risk, but it is impossible to be aware of all of them or to know whether or when they might occur. An investor in health-care stocks may be aware that a major shift in government regulations could affect the profitability of the companies they are invested in, but they cannot know when new regulations will go into effect, how the regulations might change over time or how companies will respond.

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