When it comes to investing, understanding the types of risks you’re exposed to is just as important as picking the right assets. Two major risk categories you’ll encounter are systematic risk and unsystematic risk. Systematic risk refers to external events that impact the entire market think inflation, interest rate hikes, or global crises. These are risks you can’t simply dodge by investing in multiple companies. On the other hand, unsystematic risk is more localized it’s tied to specific companies or industries. The good news? You can reduce it with smart diversification. While you can’t escape market-wide risks, diversifying your investments across sectors, geographies, and fund types can help reduce exposure to company-specific shocks. Mutual funds make this easier by pooling assets across a range of instruments. Compare Mutual Fund Options Now!
In this guide, we will break down what each type of risk means, how they differ, and which one you can control. By the end, you’ll have a clearer understanding of how to build a more resilient investment portfolio.
What is a systematic risk?
Systematic risk is the kind of risk that rattles the entire market or financial system. It’s not about one company or sector—it's about external forces that ripple through everything. Whether it's inflation, interest rate changes, political unrest, or economic slowdowns, systematic risks are broad, unavoidable, and affect most investments at the same time. For instance, imagine a major recession or a geopolitical crisis—these situations usually lead to market-wide sell-offs. One clear example was the COVID-19 pandemic in 2020. As the virus spread and lockdowns hit, stock markets around the world tanked. The BSE Sensex and NSE Nifty both saw sharp declines, regardless of how individual companies were performing.
This kind of risk is tough to sidestep. You can’t beat it by just spreading your money across sectors. Instead, you need broader strategies like asset allocation or hedging to manage its effects. In such cases, diversifying across asset classes becomes critical mixing equity, debt, and liquid options can soften the blow of market-wide disruptions. Mutual funds offer built-in asset allocation features that help balance your risk across changing market cycles. Explore Top-Performing Mutual Funds!
What is an unsystematic risk?
Unsystematic risk is all about the risks tied to a specific company or industry—it doesn’t shake the whole market. Think of it as issues like poor management, a failed product launch, regulatory changes in one sector, or even internal fraud. These risks don’t usually affect other companies or sectors. Take this example: a pharmaceutical company loses the right to sell one of its key drugs due to new health regulations. This may impact that company and perhaps some peers in the sector—but it won’t tank the entire stock market.
Luckily, unsystematic risk is something investors can control. The key is diversification. By spreading your money across different companies, sectors, or even asset classes, you can lower the chances of a single failure dragging down your whole portfolio.
Systematic risk vs. Unsystematic risk – A comparison table
To get a quick snapshot of how these two risks differ, here’s a comparison across key parameters:
Parameters |
Systematic Risk |
Unsystematic Risk |
What does it mean? |
Risk that affects the whole market |
Risk that affects specific companies or industries |
Quantum of impact |
Market-wide, large-scale impact |
Localised to one or few securities |
Controllability |
Cannot be controlled |
Can be controlled through diversification |
Management approach |
Hedging, asset allocation |
Diversification |
Examples |
Inflation, market crashes, rate hikes |
Product recalls, fraud, sector downturns |
Avoidable? |
No |
Yes, with smart strategy |
Systematic risk vs. Unsystematic risk: Key differences summarized
Let’s simplify it even further. Systematic risk is big-picture, market-wide, and driven by macroeconomic factors. Unsystematic risk is smaller in scope, tied to internal company or industry-specific issues.
For example:
- Systematic: When interest rates rise, all companies may feel the pinch.
- Unsystematic: If a company gets caught in a lawsuit, its stock may tank—but others in the same sector may stay unaffected.
Systematic risk affects everyone in the market and is beyond an investor’s control. It’s like bad weather no umbrella can stop it, but you can plan better. Unsystematic risk, however, is like driving on a bumpy road. You can avoid potholes if you know where they are—by doing your research and spreading your investments wisely.
Advantages of systematic risk
While systematic risk is often seen as something to avoid, savvy investors know that understanding it can unlock strategic opportunities. Here are some potential upsides:
- Predictability: Macroeconomic trends like inflation or policy changes often unfold gradually, giving time to respond.
- Insight into the economy: Systematic risks act as indicators of the economy’s health, helping investors align their strategy.
- Long-term opportunities: Market-wide downturns, though painful, create buying opportunities at lower prices.
- Pushes diversification: It encourages investors to balance their portfolios with different asset classes and geographies.
- Better risk awareness: Recognising systematic risks helps in adopting protective strategies like hedging or adjusting allocations.
By anticipating these trends and diversifying investments across asset types and geographies, you can position your portfolio for long-term growth. Mutual funds offer a practical way to achieve this balance through professionally managed asset allocation. Compare Mutual Fund Options Now!
Disadvantages of systematic risk
Despite its advantages, systematic risk comes with several inherent challenges that investors can’t fully escape:
- Can’t be diversified away: It hits every investor, no matter how diversified the portfolio is.
- Increased volatility: Market-wide swings due to external events can reduce portfolio value rapidly.
- Difficult to predict: Events like political unrest or global crises can occur suddenly.
- Greater potential for losses: Economic downturns may result in large capital erosion.
- Low control: You can’t influence inflation, interest rates, or government policies.
Types of systematic risks
Systematic risks can be of various types, each impacting investments differently:
- Interest rate risk: When interest rates go up, the prices of existing bonds usually go down. This impacts fixed-income portfolios significantly.
- Market risk: Caused by general market sentiment or panic. Even strong companies can see their share prices fall if the market turns bearish.
- Purchasing power risk (inflation risk): As inflation rises, the value of your money decreases. Your returns might not keep up with rising costs.
Advantages of unsystematic risk
Unsystematic risk might seem negative at first, but for informed investors, it also opens up unique advantages:
- Diversification benefits: Since unsystematic risk is company- or sector-specific, it can be reduced by spreading investments across industries.
- Active management edge: Investors can use stock-specific insights to pick winners and avoid potential underperformers.
- Opportunity for alpha: Skilled research and analysis can uncover undervalued companies and deliver market-beating returns.
- Customised risk control: You can actively tweak your portfolio based on news, earnings, or regulatory shifts affecting specific firms.
- In-depth understanding: Tracking company-level performance helps sharpen decision-making and encourages learning.
Disadvantages of unsystematic risk
Even though it can be managed, unsystematic risk comes with its own set of challenges:
- Needs constant monitoring: Company or sector-specific events can happen suddenly, requiring quick decision-making.
- Limited protection if not diversified: Investing in a few stocks or sectors increases vulnerability.
- Requires research: Analysing companies deeply is time-consuming and demands financial literacy.
- High volatility in specific assets: Events like product recalls or leadership changes can cause sharp price swings.
- Higher risk for smaller portfolios: Fewer investments mean more exposure to individual asset risks.
Types of unsystematic risks
Unsystematic risks typically fall into two main categories:
- Business risk: These are risks tied to the company’s internal operations. For example, regulatory hurdles, supply chain disruptions, or a failed product launch can all hurt earnings and investor confidence.
- Financial risk: This involves the way a company is funded. Companies with high debt may struggle in uncertain times, as interest obligations pile up. A poor debt-to-equity ratio can signal deeper instability or even bankruptcy risk.
How are systematic risk and unsystematic risks measured?
To manage investment risks effectively, it’s important to know how to measure them. Let’s break it down:
Systematic risk is commonly measured using:
- Beta: A value above 1 means more volatility than the market, while below 1 indicates lower volatility.
- CAPM (Capital Asset Pricing Model): It estimates expected returns by factoring in the risk-free rate, beta, and market return.
Unsystematic risk is measured using:
- Fundamental analysis: Examines company-specific aspects like earnings, debt, and management quality.
- Statistical tools: Metrics like variance, standard deviation, and the Sharpe ratio are often used to analyse total portfolio risk, which includes unsystematic elements.
Are systematic risks and unsystematic risks diversifiable?
This is one of the key differences between the two:
- Systematic risk is not diversifiable. That’s because it stems from broad macroeconomic events—like inflation or a financial crisis—that affect all investments to some extent. Even if you diversify across industries, you can’t eliminate this risk completely.
- Unsystematic risk is diversifiable. Since it’s company- or industry-specific, spreading your investments across sectors reduces its impact. For instance, a poor earnings report from a single company won’t harm your entire portfolio if you’re invested in other unrelated sectors.
One of the most accessible ways to diversify effectively especially for new or busy investors is through mutual funds. They pool money across various sectors and companies, helping reduce exposure to unsystematic risk. Explore Top-Performing Mutual Funds!
Is business risk systematic or unsystematic?
Business risk falls under unsystematic risk. It’s linked to internal factors within a company or its industry, such as:
- Supply chain issues
- Leadership changes
- Labour strikes
- Product recalls
Because these risks don’t affect the entire market, they can be reduced through diversification. For example, if one of your portfolio companies is affected by a factory fire, your overall investments won’t be severely impacted if your money is also spread across tech, pharma, and financial stocks.
On the other hand, systematic risks—like a market crash or recession—are much harder to avoid and affect every company regardless of its individual performance.
Systematic and unsystematic risks impact on different asset classes
Different asset classes respond differently to systematic and unsystematic risks. Let’s see how:
- Stocks
Stocks are vulnerable to both types of risk. Systematic risk comes from market-wide factors—like economic downturns—that can pull down stock prices across the board. Unsystematic risk, however, is more company- or sector-specific. For example, poor earnings or industry disruption may affect a particular stock. - Bonds
Bonds are especially exposed to interest rate risk, a key systematic factor. When rates rise, bond prices fall. Credit risk, on the other hand, is unsystematic—it varies by issuer. Corporate bonds face more unsystematic risk than government bonds. - Real estate
This sector is influenced by economic trends (systematic risk), such as recessions or policy changes, and property-level issues (unsystematic risk), like location demand or tenant default. - Other asset classes
Cryptocurrencies, commodities, and collectibles carry both risks too. For example, geopolitical tension (systematic) may affect oil prices, while platform hacks (unsystematic) may impact a single crypto exchange.
Similarities between systematic risk and unsystematic risk
While they operate at different levels, these two risk types have more in common than you might expect:
- Both affect investment returns: They influence the gains or losses you may see in your portfolio.
- Both are measurable: Tools like beta, standard deviation, and variance help investors gauge their portfolio’s risk exposure.
- Both require active management: Systematic risks are often tackled with asset allocation and hedging, while unsystematic risks are handled through diversification.
- Both are used in risk models: Financial models like the Capital Asset Pricing Model (CAPM) factor in both to estimate expected returns.
How to invest while considering systematic risk vs. unsystematic risk?
Smart investing means managing both risk types thoughtfully:
- For systematic risk, focus on asset allocation. Spread your investments across:
- Stocks
- Bonds
- Real estate
- Cash equivalents
This reduces your exposure to market-wide shocks.
- For unsystematic risk, the key strategy is diversification. Avoid putting all your money in one company or sector. Mutual funds and ETFs make this easier by offering exposure to multiple assets.
Let’s say you invest 70% in equities and 30% in other assets. Within equities, you diversify across 10–15 stocks in different sectors. This way, even if one fails, others might hold steady or grow.
If you are unsure how to build a diversified portfolio on your own, mutual funds can offer a ready-made solution by balancing exposure across sectors, risk levels, and asset classes all managed by professionals. Compare Mutual Fund Options Now!
Key takeaways
Here’s a quick summary to reinforce the key insights from the article:
- Systematic risk impacts the entire market or a large segment of it. It’s influenced by external factors such as inflation, interest rates, political changes, and economic recessions.
- You cannot eliminate systematic risk through diversification, but you can manage it using asset allocation and hedging strategies.
- Unsystematic risk is specific to individual companies or sectors and stems from internal factors like management quality, legal issues, or sector-specific problems.
- This risk can be minimised by diversifying your investments across different sectors, industries, or asset classes.
- Both risks are important when planning your portfolio and understanding your risk-return trade-off.
- Measuring tools like beta, standard deviation, and CAPM can help evaluate your risk exposure.
- A balanced, informed investment approach should consider both types of risk for long-term success.
Conclusion
Understanding systematic and unsystematic risk isn’t just for expert investors it’s a basic requirement for anyone serious about building a stable financial future. Systematic risks driven by market-wide factors like inflation or political unrest are unavoidable but manageable. Unsystematic risks, on the other hand, are specific to companies or industries and can be reduced by diversifying your investments. By blending strategies like asset allocation, hedging, and diversification, you create a buffer against both types of risk. This allows your portfolio to withstand volatility, adapt to market shifts, and pursue long-term growth with greater confidence.
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