What is Systematic Risk?
Systematic risk, also called market risk or non-diversifiable risk, refers to factors that affect the entire market simultaneously. Recessions, interest rate changes, pandemics, wars, and major policy shifts are examples. No matter how many different stocks you hold, systematic risk cannot be diversified away because it moves all assets in the same direction.
Systematic vs. Unsystematic Risk
Unsystematic risk is specific to individual companies or sectors and can be reduced by holding a diversified portfolio. A well-diversified portfolio of 30 or more stocks eliminates most unsystematic risk, leaving systematic risk as the dominant factor. Beta measures a stock's sensitivity to systematic risk: a beta of 1.2 means the stock tends to move 20% more than the market in either direction.
Key Considerations
Since systematic risk cannot be diversified away, investors are compensated for bearing it through the equity risk premium. The only ways to reduce systematic risk exposure are to shift allocation toward less volatile asset classes like bonds or cash, or to use hedging instruments such as put options. Understanding your tolerance for systematic risk is fundamental to choosing an appropriate asset allocation.