Market-wide systemic risk is a given, reflecting the influence of monetary, geopolitical, and economic variables.
Unsystematic risk, which affects a particular sector of the economy or type of security, is distinct from this sort of risk. Systematic risk is frequently regarded as being challenging to avoid because it is entirely unpredictable. The effects of systematic risk can be somewhat reduced by investors by diversifying their portfolio.
Other investment hazards, including industry risk, are driven by systematic risk. It is possible to diversify by investing in several stocks in different industries, such as healthcare and infrastructure, if an investor, for instance, has placed an excessive amount of attention on cybersecurity firms. However, among other significant changes, systematic risk includes fluctuations in interest rates, inflation, recessions, and wars.
Systematic danger is both unforeseeable and utterly unavoidable. Diversification cannot reduce it; only hedging or the appropriate asset allocation strategy does. Investors should make sure their portfolios contain a variety of asset types, such as fixed income, cash, and real estate, as each will respond differently in the case of a significant systemic change, to assist manage systematic risk. By examining the beta of a given security, fund, or portfolio, an investor can determine the systematic risk involved. The investment’s beta compares its volatility to the market. If the investment’s beta is larger than 1, it has a higher systematic risk than the market, whereas a beta of less than 1 has a lower systematic risk than the market.