Systematic risk is the risk that affects the entire financial market due to economic or global events like inflation, recessions, wars, or interest rate changes.
Systematic risk is unpredictable and impossible to completely avoid. It’s also known as un-diversifiable risk, volatility risk, or market risk. It’s the result of macroeconomic events that affect the market as a whole and cannot be controlled, at least by an investor. The Great Recession is a primary example. Investors can adjust their portfolios accordingly, however.
When discussing what is systematic risk, it is important to understand that it impacts entire financial markets rather than one specific company or industry. Many investors often compare systematic risk vs market risk because both terms are closely connected and are generally used interchangeably in finance.
Systematic risk can’t be mitigated through diversification, only through hedging or by using the correct asset allocation strategy. It underlies other investment risks such as industry risk.
It’s possible to diversify by investing in a range of stocks in other sectors such as healthcare and infrastructure if an investor has placed too much emphasis on cybersecurity stocks. Is systematic risk diversifiable is a common question among beginners, and the simple answer is no because these risks affect the entire market.
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Systematic risk incorporates interest rate changes, inflation, recessions, and wars, however. Shifts in these domains can affect the entire market and can’t be mitigated by changing positions within a portfolio of public equities.
Investors should ensure that their portfolios include a variety of asset classes to help manage systematic risk. These might include fixed income, cash, and real estate, each of which will react differently in the event of a major systematic change. An increase in interest rates 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.
Ensuring that a portfolio incorporates ample income-generating securities will mitigate the loss of value in some equities in the event of an interest rate rise.
The causes of systematic risk are largely in part related to macroeconomic events, where a domino effect is frequently observed in the global financial system.
The following list outlines systematic risk examples that represent sources of systematic risk.
These are considered major types of systematic risk because they impact almost every sector and market participant simultaneously.
Systematic risk vs unsystematic risk is one of the most important concepts in investing.
It is the opposite of systematic risk. It affects a very specific group of securities or an individual security. Unsystematic risk can be mitigated through diversification.
Systematic risks are distinct from unsystematic risks mainly in terms of scope. This means that systematic risks affect the entire market while unsystematic risks will affect an individual company, industry, or sector.
One can say that systematic risks refer to the probabilities of losses in relation to the entire market or part of it but in case of unsystematic risks, they refer to probabilities of losses for an industry or particular security.
In order to determine the level of systematic risks related to an investment such as a stock, fund or portfolio, one should just consider its beta. This beta will measure the degree of volatility of the investment in comparison to the general market.
Beta > 1 implies that the investment carries more systematic risk. If Beta < 1, it implies lower systematic risk than the market. Beta = 1 will imply same systematic risk as the market.
Many investors use beta to calculate systematic risk because it helps measure how sensitive an investment is compared to market movements.
Systematic risk is different from systemic risk which is the risk that a specific event can cause a major shock to the system.
The Great Recession provides one of the best systematic risk examples. Anyone who was invested in the market in 2008 saw the values of their investments change drastically due to this economic event.
The Great Recession affected asset classes in different ways. Riskier securities that were more leveraged were sold off in large quantities. Simpler assets such as U.S. Treasury bonds became more valuable.
Other systematic risk examples include global inflation spikes, pandemics, major wars, and sudden interest rate hikes by central banks.
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The opposite of systematic risk is unsystematic risk. It affects a very specific group of securities or an individual security.
Unsystematic risk can be mitigated through diversification. Systematic risk can be thought of as the probability of a loss that’s associated with the entire market or a segment of the market. Unsystematic risk refers to the probability of a loss within a specific industry or security.
Understanding systematic risk vs unsystematic risk helps investors create better-balanced portfolios and make informed decisions during uncertain market conditions.
Systematic risk is both unpredictable and impossible to completely avoid but investors can manage it by ensuring that their portfolios include a variety of asset classes. These might include 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 will make some new-issue bonds more valuable while causing some company stocks to decrease in value. Making sure that a portfolio incorporates ample income-generating securities will mitigate the loss of value in some equities.
Although investors often ask can you reduce systematic risk, the practical answer is that it cannot be eliminated entirely, but it can be managed through hedging strategies and proper asset allocation. Look for a reliable platform to start trading, join forex broker services trusted by traders worldwide for powerful tools and smooth execution.
An investor can identify the systematic risk of a particular security, fund, or portfolio by looking at its beta.
It indicates the volatility of that asset relative to the general market. When beta is above one, then the asset is considered more exposed to market risk than the market itself. If beta is below one, then the asset is considered less exposed to market risk than the market. In case beta equals one, then the asset is equally exposed to market risk as the market itself.
The systematic risk is usually computed by financial analysts using the beta value for each individual investment.
As opposed to individual businesses, systemic risks pertain to risks involving the whole market or economy rather than just a single business. This kind of risk is known as inherent risk.
Systemic risk can also be termed as market risk or undiversifiable risk due to its origin from a number of external factors, such as inflation, recessions, wars, fluctuations in interest rates, foreign exchange rates, natural disasters, and other economic events on a macroeconomic level.
Understanding types of systematic risk allows investors to prepare better for market-wide uncertainty and financial downturns.
Systematic risk cannot be controlled by diversification; however, such risk may still pose a threat to all investments within a particular market or economy. As such, investors should always bear in mind the presence of such a risk before taking any investment decision.
Many investors researching what is systematic risk also compare systematic risk vs market risk to better understand how global financial events impact their portfolios.
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