Systematic and Unsystematic Risk

While investing in a stock market, one must take into account the risk that affects the stock return i.e. systematic risk and unsystematic risk. This can be differentiated as below:

Systematic Risk

Systematic risk refers to risk that cannot be diversified away (non-diversifiable risk). It is uncontrollable by an organisation and is macro in nature e.g. interest rate risk, inflations, war. Investors have to face the systematic risks, regardless. For instance, a global recession affects the whole share market and not just one single share. Similarly, interest rates increase affects every stock in the market. For example, Black Monday in 1987, stock markets crashed and almost all stock dropped in significant value in that single day (Colombo, 2012).

Unsystematic Risk

Unsystematic risk is unique to an industry which affects the variability in stock or security return. It is also known as “unique risk” as it is due to influence of internal factors prevailing within a company. From an organisation’s point of view, this is controllable. i.e. business risk, financial risk and operational risk. For example, the long running row over cost cutting caused staff at British Airways to go on strike in 2010, causing a loss of £142m in revenues, subsequently causing it share value to suffer (R.Massey, 2010).

Investors may mitigate this risk by diversifying their portfolio.  Following an increase of securities in a portfolio, the portfolio’s standard deviation of the rate of return reduces. It is said that unsystematic risk can be fully diversified by holding 15–20 asset portfolio (Wiley, 2004).