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What is Diversifiable Risk?

Definition: Diversifiable Risk, also known as unsystematic risk, is defined as the danger of an event that would affect an industry and not the market. This type of risk can only be mitigated through diversifying investments and maintaining a portfolio diversification. You can of this like putting all of your eggs in one basket.

What Does Diversifiable Risk Mean?

What is the definition of diversifiable risk? This concept is best understood by breaking down the requisite elements. The risk element is defined as a potential risk confined to that company or its market. If a company or investor has a diversified portfolio, then the risk is mitigated because the company’s other investments will not be affected. The term diversifiable risk is also synonymous with unsystematic risk. Things that would be considered unsystematic would be strikes, product malfunctions, boycotts etc.

This term is often used in business when assessing the security of one’s portfolio. The investor who only owns investments in one company has a high nonsystematic risk. By investing in other company stocks and changing his portfolio mix, the investor can lower the impact of an adverse event in one industry having a devastating effect on their entire portfolio.

Let’s take a look at an example.

Example

Johnny owns stock in a car company. Recent reports have been released that show the car company Johnny has invested in actively practices discrimination. Because of these reports, multiple boycotts that target this car company have been initiated. The longstanding effects of this boycott have damaged the car company’s stock and Johnny is beginning to see a negative return on his investment.

Scenario 1: Johnny does not have investments in any other companies, so Johnny’s residual risk was extremely high in this instance.

Scenario 2: Johnny has several investments in unrelated sectors, so his risk was relatively low because the boycott only affects part of his portfolio.

This event qualifies as an unsystematic risk because the general risk of a boycott occurring is not systematic. Boycotts are events that cannot typically be foreseen, are not inevitable and do not occur with any level of regularity.

Summary Definition

Define Diversifiable Risk: Diversifiable risk means the hazard associated with investing all of a portfolio in one business or sector.

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