Systematic risk has to do with the risk that is present in any segment of a marketplace, or in the market as a whole. Sometimes referred to as market risk or undiversifiable risk, this type of risk has the potential to impact an entire market segment or even the whole market, and cannot be avoided with the use of various investment strategies. While systemic risk is inherent and cannot be avoided, there are ways to minimize the effects of the risk and protect the investment portfolio to some degree.
Any type of systematic risk will have far-reaching effects that go beyond impacting a particular security or some small group of securities. One example of this type of risk is war. When engaged in a war, the economy is severely affected in a number of ways. While certain sectors of the marketplace may thrive during wartime, there is also great potential for many more market sectors to be adversely affected, especially if the war itself decreases demand for certain goods or services, or diverts resources needed by those industries to manufacture their product lines.
Entering into a period of recession is another example of a systematic risk. With a recession, many industries are likely to suffer. Shifts in the costs of goods and services, changes in consumer demand, and the resulting unemployment that occurs often affects the manufacturing, banking, telecommunications, real estate, and even the retail industry in extremely significant ways. For the investor, a recession can mean preparing for significant losses on investments that were previously profitable. The investor may chose to ride out the economic period in hopes those investments will recover, or try to sell them, cut the losses, and identify any type of investment that is more likely to at least hold its value until the recession has passed.
While avoiding the impact of any type of systematic risk is highly unlikely, there are ways to face that risk and attempt to mitigate the effect to some degree. Some investors have found that the strategy of hedging can minimize the damage done by this type of risk. While others see the approach of varying the holdings in a portfolio as an effective way to deal with a systematic risk, even the most diversified collection of assets still has some degree of risk involved, and is likely to suffer at least some amount of loss.
