Systematic vs. Unsystematic Risk - Risk Management - YouTube

Hey everyone.

This is Kirk, here again at optionalpha.com.

And in this video, we are going to be talking about systematic versus unsystematic risk.

Now, this is a little bit more of a high-level concept, but I think that you guys are really

going to enjoy this video.

I'm going to try to keep it as short and sweet as possible.

I know I could talk probably hours and days about portfolio stuff.

But in this video, we're just going to touch on these two basic concepts and go through

them.

So, we all know that all investments have risk.

So, it's safe to assume that all stocks have risk as well, right?

But did you know that there were different types of risk?

Not all risk is the same.

So, most people think that all risk is the same.

It's not true.

There are some risks that you can avoid via diversification, and we'll talk about those,

and then other types of risks which are 100% completely unavoidable.

I bet you didn't hear anyone say that recently, that you can completely have a risk that is

100% unavoidable, meaning you can't hedge it, you can't get rid of it, it's always there.

So, that is the systematic risk.

Systematic risk is due to risk factors that affect the entire market, such as investment

policy changes, foreign investment policy, taxation, shift in social economic parameters,

global security threats, etc.

For example: Black Monday on October 19th, 1987 was a systematic event in that almost

all stocks fell in value on that single day.

We could also say that a systematic event was 9/11, right?

No one had ever factored in the fact that two planes would fly into the World Trade

Center, into the Pentagon, would crash in Pennsylvania.

No one ever knew that.

That's a risk that is unavoidable and it affects the entire market.

So, this type of risk (the systematic risk) is beyond the control of investors.

Me or you or anybody, we can't control this and it cannot be mitigated.

Now, we have unsystematic risk.

Now, unsystematic risk is due to factors specific to an industry or a company, like product

category, research and development, pricing, and marketing strategy.

So, if you owned one stock and if that company went bankrupt, you'd lose 100% of your portfolio,

right?

But what if you owned 100 stocks and that one company still went bankrupt?

You would only have lost 1% of your portfolio.

So, you can see that this type of risk is avoidable, yet the market does compensate

investors for taking such exposure.

I would say that unsystematic risk would be risk if you're in, let's say the aerospace

industry or the cotton industry or you're in the electronics industry or the computer

industry or the oil and natural gas industry.

Those all have risks in and of themselves that are different than every other industry

out there.

Now, you can get rid of that risk and avoid some of that risk via diversification, buying

a whole bunch of different securities that are not related to one another in any way,

shape or form, or have minimal relation between them.

And that�s how you avoid that.

In portfolio theory, what we really talk about here is the fact that the more number of securities

you have in a portfolio - Generally speaking, there is a max and that's called the efficient

frontier which we will talk about in another video.

But generally speaking, the more number of securities or the more stocks you hold in

a portfolio, the less unsystematic risk you're going to have in that portfolio.

And you can see how this unsystematic risk feature here is going to decrease.

Now, risk is measured up and down on this sidebar here.

And so, there's a certain level of systematic risk which is always present, and that's marked

here by this A to B line.

And you can see that this systematic risk is always present, and it's present no matter

how many securities we have in the portfolio.

We could have the most diversified portfolio on earth, but that still doesn't change the

fact that on 9/11, two planes hit the World Trade Center and that terrorist attack was

something that was completely unavoidable.

No one knew that was coming.

But for unsystematic risk which is just specific to different industries and companies, you

can avoid that risk and reduce your risk by diversifying the number of stocks you have,

the industry, the sector, the country, etc.

So generally speaking, the more you have, the closer you're going to get to just pure

systematic risk, and that is always a good thing, right?

You want to reduce as much risk in your portfolio as possible.

So hopefully, this video has been really helpful to tell you guys more about systematic versus

unsystematic risk.

Again, we've only touched the basis or touched the tip of the iceberg here when it comes

to portfolio theory.

But as always, check out more of our videos at optionalpha.com.

Thanks for watching, and take a second just to share this video with any of your friends,

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