Market Risk (Systematic Risk)
All the risks covered so far can affect individual securities or specific investment types. Market risk is different: it affects everything.
What Is Market Risk?
- Market risk (also called systematic risk or non-diversifiable risk) is the risk that the overall market declines, dragging down most securities regardless of their individual merit
- Caused by broad economic, political, or social factors that affect all securities simultaneously
- Cannot be eliminated through diversification (even a portfolio holding 1,000 different stocks is exposed to market risk)
Exam Tip: Gotchas
"Systematic" and "market risk" and "non-diversifiable risk" all refer to the same thing. The exam likes to ask for the synonym you did not expect.
Examples of Systematic Risk Events
- Recessions
- Wars and geopolitical conflicts
- Pandemics
- Interest rate changes by the Federal Reserve
- Inflation spikes
- Major policy changes (tax law, trade policy)
Exam Tip: Gotchas
Interest rate changes from the Federal Reserve are a systematic (market) risk, not an issuer-specific risk. They affect bond prices across the board, not just one company.
Beta: Measuring Market Risk
- Beta measures a security's sensitivity to market movements
- A benchmark market index (like the S&P 500) has a beta of 1.0
| Beta Value | Meaning | Example |
|---|---|---|
| Beta = 1.0 | Moves with the market | S&P 500 index fund |
| Beta > 1.0 | More volatile than the market | Technology stocks (beta 1.3 means 30% more volatile) |
| Beta < 1.0 | Less volatile than the market | Utility stocks (beta 0.6 means 40% less volatile) |
| Beta = 0 | No correlation to the market | Certain alternative investments |
| Negative beta | Moves opposite to the market | Gold (sometimes), inverse ETFs |
Think of it this way: Beta tells you how wild the ride is compared to the overall market. A beta of 1.5 means if the market drops 10%, that stock tends to drop about 15%. A beta of 0.5 means it would only drop about 5%. Higher beta means more amplified swings in both directions.
Exam Tip: Gotchas
The market benchmark has a beta of 1.0, not 0. A beta > 1 means more volatile than the market; beta < 1 means less volatile. Beta of 0 means no correlation.
Why Diversification Cannot Help
- Systematic risk affects the entire market. There is no "safe" corner to hide in during a broad downturn
- In major downturns, stocks, real estate, and corporate bonds can all fall together
- The only tools that can reduce systematic risk are hedging (using options or inverse ETFs) and asset allocation (shifting between asset classes)
Exam Tip: Gotchas
- Systematic risk CANNOT be diversified away. Diversification only eliminates non-systematic risk. If a question asks what risk remains in a fully diversified portfolio, the answer is systematic/market risk.
Systematic risk affects everything. But there is another category of risk that can be managed, and even eliminated: non-systematic risk.