Risks can be classified as Systemic and Non-Systemic risks.
Systemic Risks
Systemic risk refers to any risk that applies to the entire market, irrespective of industry. For example, the risk of interest rates rising affects everyone since they are not applicable to a particular industry, business, product or service. The risk of war, inflation, recession, and other such risks are classified as systemic risks. It is not possible to diversify, reduce, or eliminate systemic risk.
Thus, for example the Great Recession that ensued after the 2008 financial crash is a systemic risk where the entire stock market lost value, not just one industry or business or region.
Only Government Bonds / Treasuries provide you some cushion during a time when such systemic risks, as the 2008 financial crisis, materialize into a real event. Bonds / Treasuries, when held to maturity, provide you a fixed income stream in the form of interest that is paid out regularly by the Government, and safety of capital which is returned to you when the Bond / Treasury matures.
Non-Systemic or Un-Systemic Risks
Non-System risk refers to risk that is particular to a business or an industry, and does not exist for other types of businesses and industries. Thus, non-systemic risk faced by the airline industry would not apply to say the retail industry.
A pharmaceutical company that is doing drug discovery for treating cancer faces non-systemic risk in that if the drug discovery fails or does not lead to a drug that can be sold, then the risk of not being able to bring that drug to market is only faced by that company.
Non-systemic risks can be reduced by diversification. Thus, you could create a portfolio of investments where the above pharmaceutical company is a small percentage of your overall portfolio, whereby the drug discovery failure has a small impact on your overall portfolio returns, instead of a major impact or wiping you out if your entire investment portfolio only consisted of the above pharmaceutical company.
Zero risk is not possible
It is difficult to construct a portfolio that has zero risk, even if you diversify. Thus, your investment or portfolio of investments will always have some percentage of systemic and non-sytemic risk. Diversification enables you to minimize the overall risk of your portfolio.
Beta – a measure of risk and volatility
Beta is the measure of risk or volatility of a particular security or asset or portfolio compared to the risk of the entire market.
Beta = 1 implies that the risk of your security / asset / portfolio is the same as market risk. Thus, if the market fluctuates by say 5%, then chances are that your security / asset / portfolio will fluctuate by a similar percentage.
Beta < 1 implies that the risk of your security / asset / portfolio is less than the risk of the entire market as a whole. Thus, if the market fluctuates by say 5%, then chances are that your security / asset / portfolio will fluctuate by less than 5%. Such security / asset / portfolio is thus considered less risky than the market as a whole. As an example, large cap (capitalization) stocks generally have a beta < 1, and such stocks fluctuate less wildly than the market.
Beta > 1 implies that the risk of your security / asset / portfolio is more than the risk of the entire market as a whole. Thus, if the market fluctuates by say 5%, then chances are that your security / asset / portfolio will fluctuate by more that 5%. Such security / asset / portfolio is thus considered more risky than the market as a whole. As an example, small cap (capitalization) stocks generally have a beta > 1, and such stocks fluctuate more wildly than the market.
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