TRADING SKILLS & ESSENTIALS RISK MANAGEMENT
Systematic Risk
By JAMES CHEN

Reviewed by GORDON SCOTT

Fact checked by PETE RATHBURN
on September 05, 2021
What Is Systematic Risk?
Systematic risk refers to the risk inherent to the entire market or market segment. Systematic risk, also known as “undiversifiable risk,” “volatility” or “market risk,” affects the overall market, not just a particular stock or industry.
KEY TAKEAWAYS
Understanding Systematic Risk
Systematic risk is both unpredictable and impossible to completely avoid. It cannot be mitigated through diversification, only through hedging or by using the correct asset allocation strategy.
Systematic risk underlies other investment risks, such as industry risk. If an investor has placed too much emphasis on cybersecurity stocks, for example, it is possible to diversify by investing in a range of stocks in other sectors, such as healthcare and infrastructure. Systematic risk, however, incorporates interest rate changes, inflation, recessions, and wars, among other major changes. Shifts in these domains can affect the entire market and cannot be mitigated by changing positions within a portfolio of public equities.
To help manage systematic risk, investors should ensure that their portfolios include a variety of asset classes, such as fixed income, cash, and real estate, each of which will react differently in the event of a major systemic change. An increase in interest rates, for example, will make some new-issue bonds more valuable, while causing some company stocks to decrease in price as investors perceive executive teams to be cutting back on spending. In the event of an interest rate rise, ensuring that a portfolio incorporates ample income-generating securities will mitigate the loss of value in some equities.
Systematic vs. Unsystematic Risk
The opposite of systematic risk is unsystematic risk which affects a very specific group of securities or an individual security. Unsystematic risk can be mitigated through diversification. While systematic risk can be thought of as the probability of a loss that is associated with the entire market or a segment thereof, unsystematic risk refers to the probability of a loss within a specific industry or security.
If you want to know how much systematic risk a particular security, fund or portfolio has, you can look at its beta, which measures how volatile that investment is compared to the overall market. A beta of greater than one means the investment has more systematic risk than the market, while less than one means less systematic risk than the market. A beta equal to one means the investment carries the same systematic risk as the market.
Systematic risk is different from systemic risk, which is the risk that a specific event can cause a major shock to the system.
Example: Systematic Risk and the Great Recession
The Great Recession also provides an example of systematic risk. Anyone who was invested in the market in 2008 saw the values of their investments change drastically from this economic event. The Great Recession affected asset classes in different ways, as riskier securities (e.g., those that were more leveraged) were sold off in large quantities, while simpler assets, such as U.S. Treasury bonds, became more valuable.1
What Is Unsystematic Risk?
The opposite of systematic risk is unsystematic risk which affects a very specific group of securities or an individual security. Unsystematic risk can be mitigated through diversification. While systematic risk can be thought of as the probability of a loss that is associated with the entire market or a segment thereof, unsystematic risk refers to the probability of a loss within a specific industry or security.
How Can an Investor Manage Systematic Risk?
While systematic risk is both unpredictable and impossible to completely avoid, investors can manage it by ensuring that their portfolios include a variety of asset classes, such as fixed income, cash, and real estate, each of which will react differently to an event that affects the overall market. An increase in interest rates, for example, will make some new-issue bonds more valuable, while causing some company stocks to decrease value. So, making sure that a portfolio incorporates ample income-generating securities will mitigate the loss of value in some equities.
What's the Relationship Between Beta and Systematic Risk?
An investor can identify the systematic risk of a particular security, fund, or portfolio by looking at its beta. Beta measures how volatile that investment is compared to the overall market. A beta of greater than 1 means the investment has more systematic risk than the market, while less than 1 means less systematic risk than the market. A beta equal to one means the investment carries the same systematic risk as the market.
ARTICLE SOURCES
Related Terms
Unsystematic Risk
Unsystematic risk is a company or industry-specific hazard that is inherent in each investment. Learn how to reduce unsystematic risks in your investments. more
Market Risk Definition
Market risk is the possibility of an investor experiencing losses due to factors that affect the overall performance of the financial markets. more
What Is a Diversified Fund?
A diversified fund is a fund that is broadly diversified across multiple market sectors or geographic regions. more
What Is Expected Return?
The expected return is the amount of profit or loss an investor can anticipate receiving on an investment over time. more
Unlevered Beta Definition
Unlevered beta (or asset beta) measures the market risk of the company without the impact of debt. more
Idiosyncratic Risk: Why a Specific Stock Is Risky Right Now
Idiosyncratic risk is the risk inherent in an asset or asset group, due to specific qualities of that asset. The risk can be managed by having a diversified investment portfolio. more
Related Articles
PORTFOLIO CONSTRUCTION
Modern Portfolio Theory: Why It's Still Hip
RISK MANAGEMENT
The Dangers Of Over-Diversifying Your Portfolio
RISK MANAGEMENT
Learn the Common Ways to Measure Risk in Investment Management
RISK MANAGEMENT
How does Beta reflect systematic risk?
RISK MANAGEMENT
Learn How Systemic and Systematic Risk Are Both Threats to Investors
ETFS
VTI: Vanguard Total Stock Market ETF
Ad
About Us
Terms of Use
Dictionary
Editorial Policy
Advertise
News
Privacy Policy
Contact Us
Careers
California Privacy Notice
Investopedia is part of the Dotdash publishing family.