Brief Definition
Unsystematic risk refers to the risks that are specific to a particular investment or company. These risks are not related to the overall market conditions but are instead influenced by factors unique to that investment or company, such as industry-specific events or company-specific issues. Unsystematic risk can be reduced by diversifying investments across different assets or industries. By spreading investments, investors can minimize the impact of negative events that may affect a single investment. The goal is to focus on the risks that are related to broader market factors, known as systematic risk, rather than the risks specific to individual investments.
Further Explanation
Unsystematic risk, also known as specific risk or diversifiable risk, refers to the risk that is specific to a particular investment or company and can be reduced or eliminated through diversification. It is the risk that is unique to an individual asset or industry and is not related to broader market factors.
Unsystematic risk arises from factors that affect a specific company or industry, such as company-specific events, management decisions, competitive dynamics, technological changes, or regulatory developments. These risks can have a significant impact on the performance of an individual investment or company, but they can be reduced by diversifying investments across different assets or industries.
By diversifying their investment portfolios, investors can mitigate unsystematic risk by spreading their investments across different companies, sectors, or asset classes. This helps to reduce the impact of negative events that may affect a single investment or industry. The goal of diversification is to minimize the impact of unsystematic risk and focus on the systematic risk that is related to broader market factors.
Unsystematic risk is considered to be “idiosyncratic” in nature, meaning it is unique to a specific investment and cannot be eliminated through broad market movements. It is important for investors to understand and manage unsystematic risk to reduce the potential impact of adverse events on their investment portfolios.
It’s worth noting that unsystematic risk can be difficult to predict or eliminate entirely, but through diversification and thorough analysis of individual investments, investors can minimize its impact on their overall portfolio.