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Unsystematic Risk

Anshika

Unsystematic risk refers to company-specific or industry-specific risk that affects a particular stock or sector and can be reduced through proper diversification.

Unsystematic risk refers to the risk associated with individual assets or companies, which can be mitigated through diversification. It is specific to a particular company or industry and is not correlated with the market as a whole.

What Is Unsystematic Risk

Unsystematic risk is the type of risk that affects a specific company or industry, such as poor management decisions, strikes, or changes in government regulations. It is also referred to as "diversifiable risk" because it can be reduced or eliminated through proper diversification within a portfolio.

Types of Unsystematic Risk

Unsystematic risk can be broken down into several types, each affecting specific companies or industries rather than the overall market.

  • Business risk
    This relates to how a company is run and how well its business model performs. It can arise from weak management decisions, operational inefficiencies, supply chain disruptions, or failure to adapt to market changes.

  • Financial risk
    This comes from the way a company manages its finances, especially its use of debt. High borrowing, poor cash flow, or difficulty in meeting repayment obligations can increase financial pressure.

  • Industry-specific risk
    These risks affect all or most companies within a particular industry. Examples include technological changes, new regulations, shifts in consumer demand, or increased competition within the sector.

  • Legal and regulatory risk
    This includes risks from lawsuits, compliance failures, or changes in laws and policies that can affect operating costs, business practices, or future growth plans.

Since these risks are linked to individual companies or sectors, they can be reduced through diversification across different stocks and industries.

Unsystematic Risk Examples

Some common examples of unsystematic risk include:

  • A Company’s Financial Trouble: If a company faces financial distress due to high debt or poor management decisions, its stock price could be negatively impacted.

  • Product Failures: A product recall or failure in quality control can significantly hurt a company’s performance and stock value.

  • Natural Disasters: A company based in a region prone to earthquakes or floods may face risks to its operations, affecting its financial performance.

  • Labor Strikes: A labor dispute or strike can disrupt operations, leading to production halts or financial losses.

Disadvantages of Unsystematic Risk

Despite its potential advantages, unsystematic risk carries notable disadvantages:

  • Limited Control: Investors have limited control over individual company risks, such as poor management or product failures, which can lead to financial losses.

  • Increased Volatility: Stocks affected by unsystematic risk may exhibit higher volatility, which can lead to sudden price drops or instability in an investor's portfolio.

  • Hard to Predict: Many aspects of unsystematic risk, such as a company’s operational issues, are difficult to predict or anticipate, making it harder for investors to mitigate them in advance.

How Unsystematic Risk Affects Investors

Unsystematic risk directly impacts investors by influencing the performance of individual stocks or bonds. If a company faces negative events like financial difficulties or a drop in market share, its stock value will likely decrease, affecting investors holding those shares. A concentrated portfolio without diversification is particularly vulnerable to this type of risk, as  stock market  fluctuations can cause significant losses.

How to Reduce Unsystematic Risk

Unsystematic risk can be reduced through diversification across different securities and sectors. By holding a broad range of assets across different industries, an investor can reduce the impact of negative events affecting individual companies. Diversification helps to balance out the unsystematic risk in a portfolio, as the performance of one stock or sector will not disproportionately affect the entire portfolio.

Conclusion

Unsystematic risk relates to factors that affect specific companies or industries rather than the overall market. It is commonly discussed in the context of business conditions, financial structure, and sector-related events. Understanding this type of risk helps explain why individual securities may behave differently even when broader market conditions remain unchanged.

Disclaimer

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.

FAQs

What is considered unsystematic risk?

Unsystematic risk refers to risks specific to an individual company or industry rather than the overall market. These risks arise from internal factors such as management decisions, operational issues, financial structure, or company-specific regulatory developments.

Which is an example of unsystematic risk?

An example of unsystematic risk is a manufacturing company facing losses due to a failed product launch or governance issues. Such events impact the specific company’s performance without necessarily affecting the broader market.

Can unsystematic risk be diversified?

Unsystematic risk can be reduced through diversification by holding securities across different companies and sectors. Losses in one investment may be offset by stable or positive performance in others within a diversified portfolio.

Hi! I’m Anshika
Financial Content Specialist

Anshika brings 7+ years of experience in stock market operations, project management, and investment banking processes. She has led cross-functional initiatives and managed the delivery of digital investment portals. Backed by industry certifications, she holds a strong foundation in financial operations. With deep expertise in capital markets, she connects strategy with execution, ensuring compliance to deliver impact. 

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