Systematic risk

Risk shared by everything in a market - the economy, interest rates, inflation, currency, broad sentiment. Also called market risk.

Example

A recession that pushes almost all listed companies down together is systematic risk; adding more companies does not help.

Important

This is the risk diversification cannot remove, which is why judging diversification by how a portfolio did in a crash is judging it on the one job it never claimed to do.

Related terms

  • Unsystematic risk — Risk attached to one specific holding - a company failing, a building burning, a borrower defaulting, a product being recalled. Also called specific or idiosyncratic risk.
  • Diversification — Holding enough genuinely different assets that no single outcome decides your result. It reduces risk specific to individual holdings; it does not reduce the risk they all share.
  • Correlation — A measure from +1 to -1 of how closely two assets have moved together over a chosen period. +1 is lockstep, 0 is no relationship, -1 is exactly opposite.

Lessons that explain it

  • Why diversification works — Spreading money across many holdings does not raise your expected return. It changes the range of outcomes around it - and in particular it removes the ones you cannot come back from. (11 min)
  • Correlation: what actually moves together — Diversification is only worth what the independence behind it is worth, and correlation is how that independence is measured - including the fact that it changes exactly when you need it not to. (12 min)
  • The first ten holdings do most of the work; the next fifty do much less — Adding holdings reduces the damage any single failure can do, but the benefit falls away quickly. Beyond a point, more names add admin and dilute your best ideas without removing much risk. (10 min)
  • Stage, sector and geography: where the spread is real — Portfolios are usually spread along the dimensions that are easy to label rather than the ones that determine whether two holdings fall together. This lesson is about telling the two apart. (11 min)
  • The job public equity does: growth you can sell on a Tuesday — Long-horizon growth plus daily liquidity is a combination no other class offers - and the price of the liquidity is a visible quote that invites you to use it. (10 min)

All 578 terms in the Investing glossary