Unsystematic risk is the risk that is specific to an individual company or industry. Unlike market risk, which affects the entire market, unsystematic risk arises from factors that impact a particular business or sector. These factors can include management decisions, product failures, or operational issues. The good news is that unsystematic risk can be reduced through diversification in your investment portfolio.

What is Unsystematic Risk?

Unsystematic risk refers to the risk that is specific to an individual company or industry. Unlike market risk, which affects the entire market, unsystematic risk arises from factors that impact a particular business or sector. These factors include management decisions, product issues, legal troubles, or operational problems within the company.

How Can You Reduce Unsystematic Risk in Your Portfolio?

You can reduce unsystematic risk in your portfolio by diversifying your investments. Diversification involves spreading your investments across different sectors and industries so that your portfolio is not overly dependent on one company or industry. If one stock or sector faces difficulties, your other investments can help balance out the risk.

1. Diversify Across Different Sectors

Investing in different sectors (such as technology, healthcare, energy, and consumer goods) reduces the impact of any one sector’s problems on your overall portfolio. For example, if the tech industry faces a downturn, your investments in healthcare or energy sectors may not be as affected.

2. Invest in Different Asset Classes

In addition to stocks, you can invest in bonds, mutual funds, and real estate. These asset classes often perform differently from stocks, helping balance your portfolio’s overall risk. For example, when the stock market goes down, bonds or real estate may not be as affected, or may even perform better.

3. Invest in Index Funds or ETFs

Index funds or Exchange-Traded Funds (ETFs) are another great way to diversify. These funds hold a broad range of stocks, representing different sectors and companies, which can reduce unsystematic risk significantly. Rather than putting all your money in one company, you’re spreading it across multiple companies within the fund.

4. Avoid Over-Concentration in One Stock

Placing too much of your money in one stock increases the risk of unsystematic risk. If that particular company faces problems, you could lose a significant portion of your investment. Try not to invest more than a certain percentage of your portfolio in a single stock to reduce risk.

5. Research and Monitor Your Investments Regularly

It's essential to stay informed about the companies or sectors you're invested in. Regularly check their financial health, management decisions, and any news that could impact the business. Early detection of problems in your investments allows you to take action, such as selling a stock before it loses too much value.