Loading the player...

What is 'Idiosyncratic Risk'

Idiosyncratic risk, also referred to as unsystematic risk, is the risk that is endemic to a particular asset such as a stock and not a whole investment portfolio. Being the opposite of systematic risk (the overall risk that affects all assets like fluctuations in the stock market or interest rates), Idiosyncratic risk can be mitigated through diversification in an investment portfolio.

BREAKING DOWN 'Idiosyncratic Risk'

Idiosyncratic risk can be thought of as the factors that affect an asset such as a stock and its underlying company at the microeconomic level. Idiosyncratic risk has little or no correlation with market risk, and can therefore be substantially mitigated or eliminated from a portfolio by using adequate diversification. Research suggests that idiosyncratic risk accounts for most of the variation in the risk of an individual stock over time rather than market risk. Since idiosyncratic risk is by definition generally unpredictable, investors seek to minimize its negative impact on an investment portfolio by diversification or hedging.

Systematic risk is the macroeconomic factors that affect not just a single asset but other assets like it and greater markets and economies as well. Systematic risk cannot be eliminated by adding more and more assets to a portfolio. For example, market risk cannot be eliminated by adding stocks of various sectors to an investment portfolio regardless of their number.

Examples of Idiosyncratic Risk

All pipeline companies, and their stocks, face the idiosyncratic risk that their pipelines may become damaged, leak oil and bring about repair expenses, lawsuits or fines from government agencies. Unfortunate circumstances like these may cause the company to decrease distributions to investors and cause the stock to fall in price. The risk of a pipeline company incurring massive damages because of an oil spill can be mitigated by investing in a broad cross-section of stocks within the portfolio. A macroeconomic factor, however, cannot be diversified away as it affects not only pipeline stocks but all stocks. If interest rates rise, for example, the value of a pipeline company's stock will likely fall in line with all other stocks. That is systematic risk.

Another example of idiosyncratic risk is a company's dependence on the CEO. When Apple CEO and co-founder, Steve Jobs, fell ill and took a leave of absence from the company, Apple's stock continued to appreciate in absolute terms, but its valuation relative to price multiples fell. After Jobs passed away, Apple's stock traded lower. Jobs was known for being a visionary and turning around Apple; as such, his leadership was part of Apple's success and ultimately its stock price.

Common Idiosyncratic Risks

Company management's decisions on financial policy, investment policy and operations are all idiosyncratic risks specific to a particular company and stock. Other examples can include location of operations and company culture. In contrast, nonidiosyncratic risks may include interest rates, inflation, economic growth or tax policy.

RELATED TERMS
  1. Diversified Fund

    A diversified fund is a fund that is broadly diversified across ...
  2. Systematic Risk

    Systematic risk, also known as market risk, is risk inherent ...
  3. Company Risk

    Company risk is the financial uncertainty faced by an investor ...
  4. Price Risk

    The risk of a decline in the value of a security or a portfolio. ...
  5. Accepting Risk

    Accepting risk occurs when a business acknowledges that the potential ...
  6. Operational Risk

    A form of risk that summarizes the risks a company or firm undertakes ...
Related Articles
  1. Small Business

    Diversification and Startup Investing

    Startup investments, considered a subset of venture capital, are subject to the same principles of diversification and portfolio management as publicly traded companies.
  2. Managing Wealth

    Why Companies Need Risk Management

    Implementing risk management strategies can save an entire organization from failure. Is yours up to snuff?
  3. Investing

    Diversification: The Right Way to Manage Risk

    Diversifying your portfolio across multiple asset classes will help you minimize investment risk.
  4. Financial Advisor

    Active Risk vs. Residual Risk: Differences and Examples

    Active risk and residual risk are common risk measurements in portfolio management. This article discusses them, their calculations and their main differences.
  5. Investing

    Balancing the Different Risks Investors Face

    One of the keys to investing successfully is to balance different types of risk.
  6. Investing

    Currency ETFs Simplify Forex Trades

    Reduce your stock portfolio's risk by trading with foreign currencies.
  7. Investing

    The Dangers Of Over-Diversifying Your Portfolio

    If you over-diversify your portfolio, you might not lose much, but you won't gain much either. Find out how to maintain a well-balanced set of investments.
  8. Managing Wealth

    Modern Portfolio Theory: Why It's Still Hip

    Investors still follow an old set of principles, known as modern portfolio theory (MPT), that reduce risk and increase returns through diversification.
  9. Managing Wealth

    Offset Risk With Options, Futures And Hedge Funds

    Though all portfolios contain some risk, there are ways to lower it. Find out how.
  10. Investing

    10 Risks That Every Stock Faces

    As an investor, the best thing you can do is to know the risks before you buy in. Find out about 10 common stock risks you should look out for.
RELATED FAQS
  1. Why should investors be concerned with risk management?

    Learn what risk management is, the difference between systematic and unsystematic risk, and why investors should be concerned ... Read Answer >>
  2. Systemic versus systematic risk: What's the difference?

    Systemic risk generally refers to an event that can trigger a collapse in a certain industry or economy as systematic risk ... Read Answer >>
  3. Financial Risk vs Business Risk

    Understand the key differences between a company's financial risk and its business risk – along with some of the factors ... Read Answer >>
  4. What are some examples of risk management techniques?

    Understand what risk management is in business and why it is a necessary component of ongoing business planning, and review ... Read Answer >>
Hot Definitions
  1. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  2. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  3. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  4. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  5. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  6. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
Trading Center