What is 'Specific Risk'

Specific risk is a risk that affects a minimal number of assets. Specific risk, as its name implies, relates to risks that are very specific to a company or small group of companies. This type of risk is the opposite of overall market risk or systematic risk. Specific risk is also referred to as “unsystematic risk” or “diversifiable risk.”

BREAKING DOWN 'Specific Risk'

An example of specific risk would be news that is specific to either one stock or a small number of stocks, such as a sudden strike by the employees of a company or a new governmental regulation affecting a particular group of companies. Diversification helps to reduce specific risk.

Company-Specific Risk

Two factors cause company-specific risk:

  • Business Risk: Both internal and external issues may cause business risk. Internal risk relates to the operational efficiency of the business. For example, management failing to take out a patent to protect a new product would be an internal risk, as it may result in the loss of competitive advantage. The Food and Drug Administration (FDA) banning a specific drug that a company sells is an example of external business risk.
  • Financial Risk: Financial risk relates to the capital structure of a company. A company needs to have an optimal level of debt and equity to continue to grow and meet its financial obligations. A weak capital structure may lead to inconsistent earnings and cash flow that could prevent a company from trading. (For more, see the Q&A: What are the major categories of financial risk for a company?)

Reducing Specific Risk Through Diversification

Investors can reduce specific risk by diversifying their portfolios. Research conducted by prominent economist Harry Markowitz found that specific risk decreases significantly if a portfolio holds approximately 30 securities. The securities should be in different sectors so that stock- or industry-specific news does not affect the majority of the portfolio. For example, a portfolio might have exposure to the healthcare, basic materials, financial, industrial goods and technology sectors. A mix of uncorrelated asset classes should also be included in a portfolio to reduce specific risk.

Investors could use exchange-traded funds (ETFs) to diversify their portfolios. ETFs can be used to track a broad-based index, such as the Standard & Poor’s 500 index (S&P 500), or follow specific industries, currencies or asset classes. For example, investors could reduce specific risk by investing in an ETF that has a balanced allocation of asset classes and sectors, such as the iShares Core Moderate Allocation fund. This means that adverse news affecting a specific asset class or sector won’t have a material impact on the portfolio’s overall return.

RELATED TERMS
  1. Company Risk

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

    Price risk is the risk of a decline in the value of a security ...
  3. Business Risk

    Business risk is the possibility a company will have lower than ...
  4. Accepting Risk

    Accepting risk occurs when a business acknowledges that the potential ...
  5. Risk Profile

    A risk profile is an evaluation of an individual or organization's ...
  6. Systematic Risk

    Systematic risk, also known as market risk, is risk inherent ...
Related Articles
  1. Personal Finance

    Risk Management Framework (RMF): An Overview

    A company must identify the type of risks it is taking, as well as measure, report on, and set systems in place to manage and limit, those risks.
  2. Investing

    The Importance Of Diversification

    Diversification is a technique that reduces risk by allocating investments among various financial instruments. Learn how to maximize your return without increasing substantial risk in your portfolio.
  3. Investing

    How To Manage Portfolio Risk

    Follow these tips to successfully manage portfolio risk.
  4. 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.
  5. Insights

    How to Invest In Developing Markets

    Developing markets can be attractive additions to many investor's portfolios, but carry additional risks that must be considered.
  6. 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.
  7. Financial Advisor

    The Importance of a Client's Risk Assessment

    Financial advisors and money managers must do a detailed risk assessment regarding each client before they can recommend a course of action.
  8. 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.
  9. Investing

    5 Investing Risk Factors And How To Avoid Them

    Each investment product has specific risks that come with it, while some risks are inherent in every investment.
RELATED FAQS
  1. How does market risk differ from specific risk?

    Learn about market risk, specific risk, hedging and diversification, and how the market risk of assets differs from the specific ... Read Answer >>
  2. 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 >>
  3. What are the major categories of financial risk for a company?

    Examine four major categories of financial risk for a business that represent potential problems that a company may have ... Read Answer >>
  4. How can companies reduce internal and external business risk?

    Understand the difference between two types of operational risk – internal risk and external risk – and how companies can ... Read Answer >>
  5. Why are mutual funds subject to market risk?

    Find out why mutual funds, like all investments, are subject to market risk, including how the different types of market ... Read Answer >>
  6. What are some common measures of risk used in risk management?

    Learn about common risk measures used in risk management and how to use common risk management techniques to assess the risk ... Read Answer >>
Trading Center