Unsystematic risk has many names such as unsystematic risk, diversifiable risk, residual risk, as well as specific risk. But why is it a specific risk? The reason is because this risk happens to particular companies and industries. Diversification can reduce unsystematic risk in an investment portfolio. The risk happens when uncertainty occurs in a company or industry’s portfolio. The epitome is a new competitor owning significant market share from the invested company in the marketplace. Another reason could be a regulatory change leading to the downfall of company sales. Then, there coils also be a product recall resulting from the management shift in the company.
Although investors could anticipate signs of unsystematic risks, it is almost impossible to be aware of the sources that lead to it. For instance, an investor is aware of the major shift in health policy for their healthcare stocks. However, it is nearly impossible for the investor to know the new laws and consumer reactions. Risks like natural disasters, outcomes of legal proceedings, and strikes are also examples of unsystematic risks. However, they are also known as diversifiable risks. Investors could take action by diversifying the portfolio. There is indeed no formula to calculate unsystematic risk. However, investors must extend it by subtracting the systematic risk from the total risk.
There are at least five types of unsystematic risk, they are business, financial, operational, strategic, legal and regulatory risk. In brief, business risks involve internal and external issues occurring in business like the loss of competitive advantage. Financial risk refers to the capital structure of a company. Operational risk happens when there are unforeseen or negligent events.
