Systematic vs. Unsystematic Risk: Understanding and Mitigating Investment Risks

Systematic risk, also known as market risk, is the risk that affects the entire market or a specific segment of the market. It's caused by external factors such as economic, political, and environmental factors that affect all securities in the market. Systematic risk cannot be eliminated through diversification.

Unsystematic risk, also known as specific risk or company-specific risk, is the risk that affects a particular company or industry. It's caused by internal factors such as management decisions, labor strikes, or product recalls. Unsystematic risk can be reduced or eliminated through diversification, as it only affects specific companies or industries.

Diversification is the process of investing in a variety of securities, such as stocks, bonds, and commodities, to reduce the overall risk of a portfolio. By investing in different securities, investors can reduce their exposure to unsystematic risk. However, systematic risk cannot be eliminated through diversification, as it affects the entire market or a specific segment of the market.