Systematic Investment Risk

Systematic risk, also known as undiversifiable risk, is a risk that affects every stock in the stock market and cannot be avoided by diversification.

Diversification — investing in different stocks that are not related to one another. The idea of diversification is that when one stock dips, the other stocks in a diverse portfolio will avoid being dragged down with it. It follows the familiar saying: "don’t put all your eggs in one basket.

Systematic investment risk is inherent to the entire market or market segment. It can affect a large number of assets. Systematic risk affects the overall market — not just a particular stock or industry. This type of investment risk is both unpredictable and impossible to avoid completely. Examples include interest rate changes, inflation, recessions, and wars.

Here’s an example: say Mike invests $1,000 in Alphabet Inc ($GOOGL). About a week later, the stock market plummets 500 points due to a recession, and Mike’s investment suffers a loss as a result. Mike’s not too happy about this, and for the next month, the market doesn’t recover. There’s no amount of financial diversification that can overcome this problem — therefore it’s systematic and affects everything. Notice how the stock market plummeted in 2008. This drop affected every stock out there and no amount of diversification could have alleviated the effect of this drop.

To further illustrate the point, here’s the same graph showing Ford ($F) and General Electric ($GE) alongside the major indexes.

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