Unsystematic risk, what is it and how to reduce it

Unsystematic risk also known as diversifiable risk or residual risk is something that every investment comes with. There is nothing that can eliminate this risk completely, but it can be reduced.

Basically unsystematic risk is the risk of something unexpected happening like a news even, or bad earnings. While you can do your best to predict how a stock will perform this kind of risk is just unforeseeable.

You may be able to look at financial ratios or whatever indicator that you look for when deciding to buy a stock, but that does not mean you will definitely make money on a trade. There are no guarantees in the stock market just like there are no guarantees in any other business adventure.

It could be that you invest into a company that you feel has a good future and is making money today and yet tomorrow the company comes under government investigation or they lose an important contract with a major business partner.

Sudden unforeseen events can have a huge role in the market and can override everything else that you have done to determine if a company is a good buy or not.

So how do you prevent it from hurting you? There is no way to predict residual risk from happening, but there is something you can do to prepare for it. You can diversify between different stocks. When you are diversified you can come out ahead even if one position does not do too well.

If you long term oriented the best thing to do is to buy a variety of different stocks. This way if some bad news comes out with 1 of your companies it will not affect another one of your stocks.

Diversifying is the key to overcoming unforeseen events, which is why it is also called diversifiable risk.