Nonsystematic risk
Also known as: non-systematic risk, unsystematic risk, diversifiable risk, company-specific risk
Nonsystematic risk is the risk unique to a specific company, industry, or security rather than the market as a whole. Unlike systematic risk, it can be reduced or nearly eliminated through diversification.
Nonsystematic risk is the portion of investment risk tied to a particular company or industry — a failed product launch, a lost lawsuit, a management scandal, or a downturn in one sector. Because these events affect individual securities rather than the entire market, holding many different investments dilutes their impact on a portfolio.
Nonsystematic risk comes in several exam-tested flavors. Business risk is the chance a company's operations underperform. Financial risk relates to a company's debt load and possible default. Regulatory and legislative risk arise from government actions targeting an industry. Liquidity or marketability risk is the danger that a security can't be sold quickly at a fair price — thinly traded stocks and limited partnerships carry it in abundance.
The defining feature of nonsystematic risk is that diversification works against it. Spreading money across many companies, industries, and asset classes means one company's stumble barely dents the whole portfolio. Studies suggest a portfolio of roughly 20 or more varied stocks eliminates most nonsystematic risk. What remains is systematic (market) risk, which no amount of diversification removes.
The Series 65, Series 7, and Series 6 exams all test this distinction. Expect questions asking you to classify a risk as systematic or nonsystematic, and to recall that diversification — including through mutual funds — addresses nonsystematic risk only.
Key takeaways
- Nonsystematic risk is company- or industry-specific risk, as opposed to risk affecting the entire market.
- Examples include business risk, financial risk, regulatory risk, and liquidity (marketability) risk.
- Diversification can reduce nonsystematic risk to near zero; it cannot remove systematic risk.
- A portfolio of roughly 20 or more varied securities eliminates most nonsystematic risk.
- Securities exams frequently ask you to classify risks as systematic vs. nonsystematic.