What Is Unsystematic Risk?

Unsystematic risk is the risk that is unique to a specific company or industry. It's also known as nonsystematic risk, 澳洲幸运5官方开奖结果体彩网:specific risk, diversifiable risk, or residual risk. In the context of an investment portfolio, unsystematic risk can be reꦓduced through diversification—while systematic risk is the risk that's inherent in the market.

Understanding Unsystematic Risk

Unsystematic risk can be described as the uncertainty inherent in a company or industry investment. 澳洲幸运5官方开奖结果体彩网:Examples of unsystematic risk include a new competitor in the marketplace with the potential to take significant market share from the company invested in, a regulatory change (which could drive down company sales), a shift in management, or a 澳洲幸运5官方开奖结果体彩网:product recall.

While investors may be able to anticipate so🍸me sources of unsystematic risk, it is nearly impossible to be aware of all risks. For instance, an investor in healthcare stocks may be aware that a major shift in health policy is on the horizon, but may not fully know the particulars of the new laws and how 𝓰companies and consumers will respond.

Other examples of unsystematic risks include strikes and outcomes of legal proceedings. This risk is also known as a diversifiable risk since it can be eliminated by sufficiently diversifying a portfolio. There isn't a formula for calculating unsystematic risk. Instead, it must be extrapolated by subtracting the systematic risk from the total risk.

Types of Unsystematic Risk

Business Risk

Both internal and external issues may cause business risk. Internal risks are tied ♚to operational efficiencies. For example, if a company plans to open a new factory, a construction delay would be an internal risk, as it may result in the loss of competitive🌜 advantage.

Financial Risk

Financial risk relates to the capital structure of a company. A company needs to have an optimal level of debt and equity to continue to grow and meet its fi🌺nancial obligations. A weak capital structure may lead to in🌠consistent earnings and cash flow that could prevent a company from trading.

When the Fed raises interest rates, some companies may be stuck with lower-yielding investments. With interest rates moving higher, they would presumably seek to replace existing low-yield debt with newer, higher-yielding debt investments. Howeverꦿ, the higher rates lower the resale value of existing debt investments, meaning the holders are stuck either selling for a loss or missing out on higher rates.

Operational Risk

澳洲幸运5官方开奖结果体彩网:Operational risks can result fr𓆏om unforeseen or negligent events, such as a breakdown in the supply chain or a critical error being overlooked in the manufacturing process. A security breach could expose confidential information about customers or other types of key proprietary data to criminals. 

Operational risk is tied to operations and the potential for failed systems or policies. These are the risks for day-to-day operations and can result from breakdowns in internal procedures, whether tied to systems or employees. For example, a refinery may experience a leak f🏅rom one of its holding tanks, shutting down production until the damage can be repaired. Meanwhile, the refinery is offline and not producing the refined products that customers are demanding, leaving the refinery without any income for a period of time.

Strategic Risk

A strategic risk may occur if a business gets stuck selling goods or services in a dying industry without a solid plan to evolve the company's offerings. A company may also encounter this risk by entering into a flawed partnership with another firm or competitor that hurts its future prospects. In the current environment, there is a rush to develop electric cars, for example, opening up a whole new field of competition within the auto industry. Those late to the game are facing significant strategic risk.

Legal and Regulatory Risk 

Legal and regulatory risk is the riꦐsk that a change in laws or regulations will hurt a business. These changes can increase operational costs or introduce legal hurdles.

When the 澳洲幸运5官方开奖结果体彩网:Food and Drug Administration (FDA) bans a specific drug, that is an exampඣle of regulatory risk for the company that produces the drug. Other typ൩es of legal risk can include errors in agreements, class-action lawsuits, or legal violations.

More drastic legal or regulatory changes can even stop a business from operating altogether, such as in April 2024, when President Biden signed a bill to ban TikTok unless its Chinese owners sold it within one year. As o🍌f May 2025, that deadline has been extended to give the company time to find a U.S. buyer.

Unsystematic Risk vs. Systematic Risk

The total risk for investments is unsystematic risk plus systematic risk. Unsystematic risk is a risk specific to a company or industry, while systematic risk is the risk tied to the broader market—also 澳洲幸运5官方开奖结果体彩网:referred to as market risk. Systematic risk is attributed to b🦹road market factors and is the investment portfolio risk that is not based on individual investments. 

Systematic risks can include interest rate changes, recessions, or inflation. Systematic risk is often calculated with beta, which measures the volatility of a stock or portfolio relative to♓ the entire market. Meanwhile, company risk is a bit more difficult to measuꦺre or calculate.

Example of Unsystematic Risk

By owning a variety of company stocks across different industries, as well as by owning other types of securities in a variety of asset cla𓂃sses, investors can reduce the impact of any single events.

For example, an investor who owns nothing but airline stocks, would face a high level of unsystematic risk (also known as 澳洲幸运5官方开奖结果体彩网:idiosyncratic risk). They would b🥀e vulnerable if airline industry empไloyees went on strike, which could temporarily sink airline stock prices. Simply the anticipation of this news could hamper their portfolio.

By adding 澳洲幸运5官方开奖结果体彩网:uncorrelated holdings to their portfolio, such as stocks outside of the transportation industry, the investor would spread out air-travel-specific concerns. Unsystematic risk, in this case, affects not only specific airlines but also other industries that airlines do business with, such as large food companies. In this regard, the investor could diversify away from public equities altogether by adding U.S. Treasury bonds as additional protection from fluctuations in stock pri෴ces.

Even a portfolio of well-diversified assets cannot escape all risk, however. The portfolio will still be exposed to 澳洲幸运5官方开奖结果体彩网:systematic risk, which refers to the uncertainty that faces the market as a whole and includes shifts in interest rates, recessions, financial crises, wars, and natural disasters.

Explain Like I'm Five

Investors try to measure all the risks of aꦿn asset to estimate their potential losses. Some risks are common ac🎀ross all assets. If a recession occurs or interest rates go up, every company will be affected. This is called systematic risk.

Unsystematic risk is the risk that is specific to a particular company or industry. Some companies might have bad leadership or face lawsuits, or they might be vulnerable to weather events that affect their supply chains. Investors can limit unsystematic risk by investing in a variety of different businesses and industries.

The Bottom Line

Unsystematic risk is diversifiable, meaning that you can reduce this risk if you buy shares of different companies across various industries. Unsystematic risks are often tied to a🔯 specific company or industry and can be avoided by building a well-diversified portfolio. 

Systematic risk is a non-diversifiable risk or a measure of overall market risk. These factors are beyond the control of the business or investor, such as economic, political, or soc🅰ial factors. Meanwhile, events that affect a specific company are unsystematic risks, such as a labor strike or the FDA denying a new drug.