Definition: 4 Types of Risk

Systemic Risk generally refers to an event that can trigger a collapse in a certain industry or economy.

Systematic Risks refers to overall market risk. It is the risk inherent to the entire market or market segment. For example, if you hold only one stock, you run the risk that something will happen to the company you invested in and not to its counterpart. If McDonald’s has a food recall, Burger King does not suffer. You can reduce systematic risk by diversifying your portfolio.

Unsystematic Risk refers to a company- or industry-specific hazard that is inherent in each investment. Things like rainy weather are called “unsystematic” risks for a company that focuses on selling products for use in sunny weather. They are unsystematic because they don’t affect the market as a whole – just an industry, or a specific company. A recent example is energy stocks. In 2016, the price of oil plummeted to per-barrel prices not seen since 1999. As a result, energy stocks plummeted in value. Because these unsystematic risks are, by their very nature, unpredictable, it is risky to bet on just one company or one industry. That’s why diversification is far more prudent than betting on what you think the next hot stock or sector might be. In general, the fewer investment vehicles you have, the larger your unsystematic risk.

Uncompensated Risk is taking risk when there is no reward, or upside. Without diversifying, you subject yourself to volatility and unsystematic risk typically with no good reason for doing so. Without a crystal ball, there’s no legitimate reason to think that certain stocks are going to outperform the market as a whole. On average, you do not reap any extra reward for that extra volatility.