How to Distinguish Between Systematic & Unsystematic Risks

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Systematic and unsystematic risks are associated with the stock market.
Systematic and unsystematic risks are associated with the stock market. (Image: Hemera Technologies/AbleStock.com/Getty Images)

Systematic and unsystematic risks are terms used in the stock market. Investors who buy securities investigate all of the risks involved with the stock beforehand. A systematic risk refers to the risks that involve an entire market or market segment; an unsystematic risk refers to the risks that are unique to one company. These two types of risks vary tremendously and are based on several factors.

Learn the components of a systematic risk. A systematic risk is involved in every market type and refers to an entire market or segment of a market. These types of risks are risks an investor inherits from major events. If a natural disaster occurs, investors often begin selling their securities because they're scared. This is a systematic risk, because the whole market is affected.

Understand what an unsystematic risk is. An unsystematic risk involves one specific security. This is the type of risk an investor takes that can occur if the business were to go bankrupt or a catastrophe were to happen.

Learn how to diversify. Systematic risks, also called undiversifiable risks, cannot be prevented by diversifying investments. Systematic risks affect an extremely large group of securities; therefore, an investor who diversifies his accounts is still subject to systematic risks. Unsystematic risks, however, can be minimized by an investor who diversifies his portfolio.

Look at an example. If, for example, the stock market crashes on one single day, an investor faces a systematic event. All of his stock prices most likely decrease on that day. In another example, if an investor owns only one stock and the company declares bankruptcy, the investor may lose his whole portfolio. That's an unsystematic risk. If this investor owned 10 different stocks and this happened, he would only lose the value of one of those stocks on that day.

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