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. Market Risk

    Market risk is the possibility of an investor experiencing losses ...
  2. Specific Risk

    Specific risk is a risk that affects a minimal number of assets.
  3. Systematic Risk

    Systematic risk, also known as market risk, is risk inherent ...
  4. Diversification

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

    The risk of a decline in the value of a security or a portfolio. ...
  6. Country Risk

    A collection of risks associated with investing in a foreign ...
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

    How to Diversify Your Portfolio Beyond Stocks

    Find out how to get diversified in asset classes beyond stocks to reduce portfolio risk. Learn how diversification can help you reach your financial goals.
  3. Investing

    3 Reasons Successful Investors Do Not Practice Diversification

    Discover why many of the most successful investors do not bother to create a diversified investment portfolio.
  4. 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.
  5. 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.
  6. Investing

    Can You Earn Money in Stocks?

    Stock ownership can build a lifetime of prosperity, but prospective investors need to avoid a host of common pitfalls.
  7. Managing Wealth

    6 Common Portfolio Protection Strategies

    Several strategies can help an investor protect against the worst.
  8. 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.
RELATED FAQS
  1. What are some common examples of unsystematic risk?

    Learn about how to identify examples of unsystematic risk, and discover how many can be traced to entrepreneurial error or ... Read Answer >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. 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 >>
Hot Definitions
  1. 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 ...
  2. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
  3. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
  4. Monte Carlo Simulation

    Monte Carlo simulations are used to model the probability of different outcomes in a process that cannot easily be predicted ...
  5. Price Elasticity of Demand

    Price elasticity of demand is a measure of the change in the quantity demanded or purchased of a product in relation to its ...
  6. Sharpe Ratio

    The Sharpe ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk.
Trading Center