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Systematic risk, also known as volatility, non-diversifiable risk or market risk, is the risk everyone assumes when investing in a market. Think of it as the overall, aggregate risk that comes from things like natural disasters, wars, broad changes in government policies and other events that cannot be planned for or avoided.

The best way to measure the amount of systematic risk an investment has is to look at the investment’s beta.  Beta measures an investment’s volatility as it correlates to market volatility. A beta greater than one means the investment has more systematic risk than the market. If the beta is less than one, then the investment has less systematic risk than the market.  If the beta equals one, then the investment has the same systematic risk as the market. The market is usually represented by a well known index like the S&P 500, The Russell 2000 Index or The MSCI World Index.

Systematic risk is important for wealth management firms and portfolio managers to helps them create strategies for their clients based on their risk profile. Systematic risk is also important for understanding valuation models like the CAPM model, which describes the relationship between risk and expected return for risky securities.

The effect of systemic risk on a portfolio can be reduced by including risk-free and less-risky assets such as U.S. Treasury securities. Unfortunately, because these ultra-safe investments don't carry much risk, they also won’t offer much of a return.  

Another type of risk, which is more prevalent, is idiosyncratic risk. This risk only affects certain types of investments or sectors, with little correlation to market risk.  Idiosyncratic risk can be hedged by diversifying a portfolio.

 

 

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