Systematic vs. Unsystematic Risk: Understanding and Diversification

Systematic risk, also known as market risk, is the risk associated with the overall market or economy. It affects all companies and assets in the market and cannot be eliminated through diversification. Examples of systematic risks include changes in interest rates, inflation, and political instability.

Unsystematic risk, also known as specific risk, is the risk associated with a particular company or asset. It can be caused by factors such as management decisions, labor strikes, and product recalls. Unsystematic risk can be reduced or eliminated through diversification because it is not related to market-wide factors. By investing in a diversified portfolio of assets that are not highly correlated with each other, unsystematic risk can be minimized.

In summary, systematic risk affects the entire market and cannot be eliminated through diversification, while unsystematic risk is specific to individual companies or assets and can be minimized through diversification.