Translation: Unsystematic Risk = Unsystematic Risk

Unsystematic Risk — also known as Specific Risk or Diversifiable Risk — refers to financial risks and challenges associated solely with a single company or a particular economic sector. These risks usually arise from specific internal or operational factors, such as management failure, poor debt management, worker strikes, technical failure in a new product, or changes to regulations and rules affecting a specific sector.

Simple definition: It is "the risk that affects your neighbor's house without affecting yours." In other words, if an airline company's share price falls because of a technical fault in its aircraft or a pilots' strike, this is "unsystematic risk" that affects that company alone and does not affect the shares of food or technology companies in the market.

Calculation method: A stock's total risk is calculated using the Standard Deviation and consists of two components:

Total Risk = Systematic Risk + Unsystematic Risk

An investor can almost eliminate the "unsystematic risk" component of this equation by distributing their investments across 15 to 20 stocks in different, unrelated sectors.

Note: The fundamental difference between it and Systematic Risk is that the latter is subject to the effects of the broader economy—such as inflation, interest rates, or wars—and affects the entire market, making it impossible to avoid through diversification, whereas unsystematic risk is limited and easy to neutralize.

Example: Suppose there are two investors (Investor A) and (Investor B), each with a portfolio worth 100,000 riyals.

  • Investor (A): Invested the entire 100,000 riyals in the shares of a single company operating in the real estate sector.
  • Investor (B): Distributed the 100,000 riyals among 10 different companies across multiple sectors (technology, food, healthcare, real estate, and banking).

Result: If that real estate company faced a management crisis or a legal loss and its profits disappeared, (Investor A) would suffer a severe loss that could consume most of their capital because they were fully exposed to "unsystematic risk." Meanwhile, (Investor B)'s portfolio would be affected only minimally because the profits from the other sectors and companies would offset this limited loss.

What does this mean for you?

  • Protecting your investment portfolio: Understanding this risk teaches you not to "put all your eggs in one basket," because incidents affecting individual companies can happen at any time.
  • The ability to control it: Unlike broad economic crises, unsystematic risk is the only part of market risk that you have the full ability to eliminate through a conscious investment decision.
  • No financial compensation for bearing it: Under modern portfolio theory, the market does not reward you with additional returns for bearing unsystematic risk, because investing in it is a free risk that you could have avoided through diversification.

Frequently asked question: Does diversification and buying many stocks protect me from all types of market risk?

Answer: No. Diversification protects you only from unsystematic risk (risks specific to companies). However, systematic risk (such as interest-rate increases or a general economic recession) will affect the entire market and your portfolio, even if it contains dozens of diversified stocks.