Non-Systematic Risk (Unsystematic Risk)
Systematic risk affects the whole market. Non-systematic risk affects only specific companies or industries, and that difference is what makes it manageable.
What Is Non-Systematic Risk?
- Non-systematic risk (also called unsystematic risk, diversifiable risk, business risk, or company-specific risk) is risk specific to a particular company, industry, or sector
- CAN be reduced or eliminated through diversification (owning securities across different companies, industries, and asset classes)
- This is the key distinction from systematic risk: non-systematic risk goes away when you diversify
Exam Tip: Gotchas
"Non-systematic," "unsystematic," "diversifiable," "business," and "company-specific" risk all refer to the same concept. Expect a synonym swap in the answer choices.
Examples of Non-Systematic Risk
- A CEO unexpectedly resigns
- A company faces a major product recall
- Workers go on strike at a manufacturing plant
- A lawsuit results in a massive judgment against a company
- Regulatory changes affect one specific industry (e.g., new environmental rules for energy companies)
Exam Tip: Gotchas
An industry-specific regulatory change hits only one sector, so it is non-systematic risk. Broad macro policy shifts (Fed rate changes, recession) hit the whole market and are systematic.
Systematic vs. Non-Systematic Risk Comparison
| Feature | Systematic (Market) Risk | Non-Systematic (Diversifiable) Risk |
|---|---|---|
| Scope | Entire market | Specific company or industry |
| Diversifiable? | No | Yes |
| Examples | Recession, inflation, rate changes | CEO departure, product failure, lawsuit |
| Measured by | Beta | Not easily quantified |
| Mitigation | Hedging (options, asset allocation) | Diversification |
How Many Securities Does It Take?
- Research suggests that holding 25-30 diversified stocks across different sectors can virtually eliminate non-systematic risk
- The remaining risk in a well-diversified portfolio is systematic (market) risk
- This is why modern portfolio theory emphasizes diversification as a fundamental strategy
Exam Tip: Gotchas
- The remaining risk in a fully diversified portfolio is systematic (market) risk. Research suggests 25-30 well-chosen securities can largely eliminate non-systematic risk.
- Systematic risk CANNOT be diversified away. Only hedging or asset allocation can mitigate it.
- Non-systematic risk CAN be diversified away by holding a variety of securities.
- If a question asks about "diversifiable risk," it means non-systematic risk.
Non-systematic risk can be managed through diversification. But there is one more specific risk type to cover before we move to mitigation strategies: political risk.