Managing risk helps investors minimize the chances of significant losses and increase the chances of achieving their investment goals.
Unfortunately, not every investor succeeds at risk management. Some fall prey to greed or one of the many cognitive biases that make investing a challenge. Others operate with an incomplete picture of what risk really means and take unnecessary chances.
To manage risk successfully, it’s important to understand the different types of risks that investors face. Armed with this knowledge, it then becomes possible to identify the most optimal strategies for protecting your downside.
With that in mind, let’s take a closer look at two of the most important and fundamental risk categories: Systematic and Unsystematic Risk.
What are Systematic Risks?
Systematic risk is risk that is inherent to the entire market or market segment. It is the risk that is not specific to any one company or investment and cannot be diversified away.
What are Systematic Risk Examples?
Examples of systematic risk include economic recessions, inflation, wars, terrorism, natural disasters, and changes in interest rates.
Here’s one specific example to help you crystallize your understanding: An automaker produces and sells automobiles. During an economic recession, there may be a decrease in demand for new cars as consumers cut back on spending. This could lead to a decrease in the company’s sales and profits, and potentially result in a decline in the value of the company’s stock.
What is Unsystematic Risk?
Unsystematic risk, also known as specific risk or diversifiable risk, is the risk that is specific to a particular company or investment. Examples of unsystematic risk include a company’s financial mismanagement, labor strikes, and product recalls.
What are Unsystematic Risk Examples?
One example of this is a company that manufactures and sells household appliances. If the company’s products are found to be prone to overheating or catching fire, the company may be required to recall the products and refund customers. This could lead to financial losses for the company, as well as damage to its reputation and potentially reduced sales in the future.
The Difference Between Systematic Risk and Unsystematic Risk
In general, unsystematic risk can be managed through diversification, while systematic risk cannot be avoided. This is why diversification is often recommended as a risk management strategy for investors.
Some other differences include:
- Systematic risk cannot be controlled, while unsystematic risk can be controlled.
- Systematic risk is much broader in scope and can impact entire economies.
- Systematic risk is caused by macro factors, whereas unsystematic risk is caused by much narrower factors related to a single organization or industry.
How to Invest for Systematic Risk vs. Unsystematic Risk
There are several ways to balance systematic and unsystematic risk when investing:
- Diversification – One of the most effective ways to manage unsystematic risk is to diversify your portfolio by holding a variety of different asset classes, such as stocks, bonds, and cash. By diversifying, you can reduce the impact of specific risks on your portfolio.
- Asset allocation – Asset allocation is the process of dividing your portfolio among different asset classes in a way that aligns with your investment goals and risk tolerance. By properly allocating your assets, you can help balance systematic and unsystematic risk in your portfolio.
- Risk management – Implementing risk management strategies, such as stop-loss orders and hedging, can help to mitigate the impact of both systematic and unsystematic risk on your portfolio.
- Regular review – It is important to regularly review your portfolio to ensure that it is properly balanced and aligned with your investment goals. This may involve rebalancing your portfolio by selling some assets and buying others to maintain your desired asset allocation.
Can You Avoid Risk When Investing?
Investors cannot completely eliminate risk, but by taking the steps outlined above, you can help to manage risk and increase the chances of achieving your investment goals.
Additionally, your investment strategy plays a major role in your level of risk. One example: Someone who invests in municipal bonds will generally assume less risk than someone who invests in a highly speculative asset. However, virtually every asset carries some risk, and no asset is completely immune to it.
How can RJO Futures Guide Traders When Systematic and Unsystematic Risks are Involved?
One of the best ways to mitigate risk in any category is to work with professionals who have deep market expertise.
RJO Futures provides investors with access to a world-class team of investment professionals who can provide critically important context and guidance with regard to systematic and unsystematic risk. If you have questions, RJO Futures is here to provide answers.
Additionally, RJO provides access to the market’s most advanced set of tools backed by a sophisticated trading platform.
In other words, RJO offers everything investors need to understand and manage risk and achieve their investment goals. Contact us today for more information!