Series 7: 10.2.1. Systematic And Nonsystematic Risk

10.2.1. Systematic and Nonsystematic Risk

A portfolio of securities is comprised of both systematic and nonsystematic risk. Systematic risk is the risk that the entire market will drop, dragging with it the performance of an individual stock or portfolio. Systematic risk is also referred to as market risk. If the performance of a portfolio drops due to systematic risk, it has dropped because the whole market has dropped, not because of the performance of the specific companies within the portfolio.

Nonsystematic risk (sometimes called unsystematic risk) is the risk that the value of the specific securities within the portfolio will decline due to factors specific to the companies issuing the security (e.g., a decline in the company’s Standard & Poor’s rating). The amount of nonsystematic risk in a portfolio depends on the number of securities in the portfolio and the correlations among the securities it contains. Stocks that are correlated tend to move in the same direction, and their volatility is additive. Stocks that are uncorrelated move randomly with respect to one another and tend to offset each other’s risk. The more diversified the portfolio, the less nonsystematic risk, because its vo