What is ‘Systematic Risk’
The risk inherent to the entire market or an entire market segment. Systematic risk, also known as “undiversifiable risk,” “volatility” or “market risk,” affects the overall market, not just a particular stock or industry. This type of risk is both unpredictable and impossible to completely avoid. It cannot be mitigated through diversification, only through hedging or by using the right asset allocation strategy.
BREAKING DOWN ‘Systematic Risk’
For example, putting some assets in bonds and other assets in stocks can mitigate systematic risk because an interest rate shift that makes bonds less valuable will tend to make stocks more valuable, and vice versa, thus limiting the overall change in the portfolio’s value from systematic changes. Interest rate changes, inflation, recessions and wars all represent sources of systematic risk because they affect the entire market. Systematic risk underlies all other investment risks.
The Great Recession provides a prime example of systematic risk. Anyone who was invested in the market in 2008 saw the values of their investments change because of this market-wide economic event, regardless of what types of securities they held. The Great Recession affected different asset classes in different ways, however, so investors with broader asset allocations were impacted less than those who held nothing but stocks.
If you want to know how much systematic risk a particular security, fund or portfolio has, you can look at its beta, which measures how volatile that investment is compared to the overall market. A beta of greater than 1 means the investment has more systematic risk than the market, less than 1 means less systematic risk than the market, and equal to one means the same systematic risk as the market.
Whereas this type of risk affects a broad range of securities, unsystematic risk affects a very specific group of securities or an individual security. Unsystematic risk can be mitigated through diversification.