Loading the player...

What is 'Unsystematic Risk'

Unsystematic risk is unique to a specific company or industry. Also known as “nonsystematic risk,” "specific risk," "diversifiable risk" or "residual risk," in the context of an investment portfolio, unsystematic risk can be reduced through diversification.

BREAKING DOWN 'Unsystematic Risk'

Unsystematic risk can be described as the uncertainty inherent in a company or industry investment. Types of unsystematic risk include a new competitor in the marketplace with the potential to take significant market share from the company invested in, a regulatory change (which could drive down company sales), a shift in management, and/or a product recall.

While investors may be able to anticipate some sources of unsystematic risk, it is impossible to be aware all or when/how these might occur. For example, an investor in healthcare stocks may be aware that a major shift in health policy is on the horizon, yet she/he cannot know in advance the particulars of the new laws and how companies and consumers will respond. The gradual adoption and then potential repeal of the Affordable Care Act, first written into law in 2010, has made it very challenging for some investors in healthcare stocks to anticipate and place confident bets on the direction of the industry and/or specific companies.

Example of Unsystematic Risk

By owning a variety of company stocks across different industries, as well as by owning other types of securities in a variety of asset classes, such as Treasuries and municipal securities, investors will be less affected by single events. For example, an investor, who owned nothing but airline stocks, would face a high level of unsystematic risk. She would be vulnerable if airline industry employees decided to go on strike, for example. This event could sink airline stock prices, even temporarily. Simply the anticipation of this news could be disastrous for her portfolio.

By adding uncorrelated holdings to her portfolio, such as stocks outside of the transportation industry, this investor would spread out air-travel-specific concerns. Unsystematic risk in this case affects not only specific airlines but also several of the industries, such as large food companies, with which many airlines do business. In this regard, she could diversify away from public equities altogether by adding US Treasury Bonds as an additional protection from fluctuations in stock prices.

Even a portfolio of well-diversified assets cannot escape all risk, however. The portfolio will still be exposed to systematic risk, which refers to the uncertainty that faces the market as a whole and includes shifts in interest rates, presidential elections, financial crises, wars, and natural disasters.

RELATED TERMS
  1. Company Risk

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

    Diversification is the strategy of investing in a variety of ...
  3. Price Risk

    Price risk is the risk of a decline in the value of a security ...
  4. Market Portfolio

    A market portfolio is a theoretical, diversified group of investments, ...
  5. Idiosyncratic Risk

    Idiosyncratic risk refers to factors that impact a particular ...
  6. Business Risk

    Business risk is the possibility a company will have lower than ...
Related Articles
  1. Investing

    Understand Risk Before You Diversify

    Before investors can use diversification to maximize investment returns, they need to understand unsystematic risk and systematic risk.
  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. Managing Wealth

    One Portfolio For Asset Allocation

    If you treat all of your investments as a single portfolio, you will be better able to maximize returns.
  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. Investing

    3 Ways to Prepare for a Market Downturn

    No one knows when a market downturn will occur or how long it will last, so it pays to be prepared.
  7. Managing Wealth

    Avoid Future Shock By Protecting Your Portfolio With Futures

    Worried about protecting your portfolio of diversified stocks and assets? Using futures with correct strategies can help.
  8. Investing

    Avoid These Portfolio Diversification Mistakes

    When diversifying a portfolio investors should avoid these common pitfalls.
  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. 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 >>
  2. What is the difference between risk avoidance and risk reduction?

    Learn what risk avoidance and risk reduction are, what the differences between the two are, and some techniques investors ... Read Answer >>
  3. 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 >>
  4. 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 >>
  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 >>
Trading Center