Difference Between Systematic and

Unsystematic Risk
There is always a risk incorporated in every investment like shares or debentures.
The two major components of risk systematic risk and unsystematic risk, which
when combined results in total risk. The systematic risk is a result of external
and uncontrollable variables, which are not industry or security specific and
affects the entire market leading to the fluctuation in prices of all the securities.

On the other hand, unsystematic risk refers to the risk which emerges out of

controlled and known variables, that are industry or security specific.

Systematic risk cannot be eliminated by diversification of portfolio, whereas the

diversification proves helpful in avoiding unsystematic risk. Take a full read of
this article to know about the differences between systematic and unsystematic
risk.
Comparison Chart

BASIS FOR
SYSTEMATIC RISK UNSYSTEMATIC RISK
COMPARISON

Meaning Systematic risk refers to the Unsystematic risk refers to

hazard which is associated the risk associated with a
with the market or market particular security, company
segment as a whole. or industry.

Nature Uncontrollable Controllable

Factors External factors Internal factors

Affects Large number of securities Only particular company.

in the market.

Types Interest risk, market risk Business risk and financial

and purchasing power risk. risk

Protection Asset allocation Portfolio diversification

 Definition of Systematic Risk

By the term ‘systematic risk’, we mean the variation in the returns on securities,
arising due to macroeconomic factors of business such as social, political or
economic factors. Such fluctuations are related to the changes in the return of the
entire market. Systematic risk is caused by the changes in government policy, the
act of nature such as natural disaster, changes in the nation’s economy,
international economic components, etc. The risk may result in the fall of the
value of investments over a period. It is divided into three categories, that are
explained as under:

 Interest risk: Risk caused by the fluctuation in the rate or interest from time to
time and affects interest-bearing securities like bonds and debentures.
 Inflation risk: Alternatively known as purchasing power risk as it adversely
affects the purchasing power of an individual. Such risk arises due to a rise in the
cost of production, the rise in wages, etc.
 Market risk: The risk influences the prices of a share, i.e. the prices will rise or
fall consistently over a period along with other shares of the market.

Definition of Unsystematic Risk

The risk arising due to the fluctuations in returns of a company’s security due to
the micro-economic factors, i.e. factors existing in the organization, is known as
unsystematic risk. The factors that cause such risk relates to a particular security
of a company or industry so influences a particular organization only. The risk
can be avoided by the organization if necessary actions are taken in this regard. It
has been divided into two category business risk and financial risk, explained as
under:

 Business risk: Risk inherent to the securities, is the company may or may not
perform well. The risk when a company performs below average is known as a
business risk. There are some factors that cause business risks like changes in
government policies, the rise in competition, change in consumer taste and
preferences, development of substitute products, technological changes, etc.
 Financial risk: Alternatively known as leveraged risk. When there is a change
in the capital structure of the company, it amounts to a financial risk. The debt –
equity ratio is the expression of such risk.
 Key Differences Between Systematic and Unsystematic Risk

The basic differences between systematic and unsystematic risk is provided in the
following points:

1. Systematic risk means the possibility of loss associated with the whole market or
market segment. Unsystematic risk means risk associated with a
particular industry or security.
2. Systematic risk is uncontrollable whereas the unsystematic risk is controllable.
3. Systematic risk arises due to macroeconomic factors. On the other hand, the
unsystematic risk arises due to the micro-economic factors.
4. Systematic risk affects a large number of securities in the market. Conversely,
unsystematic risk affects securities of a particular company.
5. Systematic risk can be eliminated through several ways like hedging, asset
allocation, As opposed to unsystematic risk that can be eliminated through
portfolio diversification.
6. Systematic risk is divided into three categories, i.e. Interest risk, market risk and
purchasing power risk. Unlike unsystematic risk, which is divided into two broad
category business risk and financial risk.

Conclusion

The circumvention of systematic and unsystematic risk is also a big task. As

external forces are involved in causing systematic risk, so these are unavoidable
as well as uncontrollable. Moreover, it affects the entire market, but can be
reduced through hedging and asset allocation. Since unsystematic risk is caused
by internal factors so that it can be easily controlled and avoided, up to a great
extent through portfolio diversification.
Systematic Risk
Systematic risk is risk associated with market returns. This is risk that can be attributed
to broad factors. It is risk to your investment portfolio that cannot be attributed to the
specific risk of individual investments.
Sources of systematic risk could be macroeconomic factors such as inflation, changes in
interest rates, fluctuations in currencies, recessions, wars, etc. Macro factors which
influence the direction and volatility of the entire market would be systematic risk. An
individual company cannot control systematic risk.
Systematic risk can be partially mitigated by asset allocation. Owning different asset
classes with low correlation can smooth portfolio volatility because asset classes react
differently to macroeconomic factors. When some asset categories  (i.e. domestic
equities, international stocks, bonds, cash, etc.) are increasing others may be falling and
vice versa.
To further reduce risk, asset allocation investment decisions should be based on
valuation. I want to adjust my asset allocation target according to valuations.  I want to
overweight those asset classes that are bargains and own less or avoid investments
which are overpriced. When mitigating systematic risk within a diversified portfolio,
cash may be the most important and under appreciated asset category.
Unsystematic Risk
Unsystematic risk is company specific or industry specific risk. This is
risk attributable or specific to the individual investment or small group
of investments. It is uncorrelated with stock market returns. Other
names used to describe unsystematic risk are specific risk,
diversifiable risk, idiosyncratic risk, and residual risk.
Examples of risk that might be specific to individual companies or
industries are business risk, financing risk, credit risk, product risk,
legal risk, liquidity risk, political risk, operational risk, etc.
Unsystematic risks are considered governable by the company or
industry.
Proper diversification can nearly eliminate unsystematic risk. If an
investor owns just one stock or bond and something negative happens
to that company the investor suffers great harm. But if an investor
owns a diversified portfolio of 20, 30, or 40 individual investments,
the damage done to the portfolio is minimized.
The important concept of unsystematic risk is that it is not correlated
to market risk and can be nearly eliminated by diversification.
Probability and Expected Value
The expected value or return of a portfolio is the sum of all the
possible returns multiplied by the probability of each possible return.
One form of risk is the amount of deviation and the probability of that
deviation from the expected return.
Portfolio risk is reduced by mitigating systematic risk with asset
allocation, and unsystematic risk with diversification. Mitigation of
systematic and unsystematic risk allows a portfolio manager to put
higher risk/reward assets in the portfolio without accepting additional
risk. This is called portfolio optimization.
In other words, a manager is willing to accept a given amount of risk.
The total risk of the portfolio is  lowered through proper asset
allocation and diversification. Now the the manager can add more
aggressive investments to the portfolio and still maintain the given
amount of risk he is willing to accept.

Conclusion
Systematic and unsystematic risks can be partially mitigated with risk
management solutions such as asset allocation, diversification, and
valuation timing. Used properly, a manager can increase portfolio
returns and/or reduce risk to optimize an investment portfolio.