Systematic risk

Systematic risk is risk built into the market as a whole. It stems from broad forces — recessions, interest rate changes, inflation, wars, political instability — that push nearly all securities in the same direction at the same time. Because every stock and bond is exposed to these forces, diversification cannot eliminate systematic risk. Owning 500 stocks instead of 5 does not protect you from a market-wide crash.

The major types of systematic risk include market risk (overall prices fall), interest rate risk (rising rates push bond prices down), inflation or purchasing power risk (returns lose real value), and currency risk for international investments. A security's sensitivity to overall market movement is measured by its beta: a beta of 1.0 moves with the market, while a beta above 1.0 amplifies market swings.

Systematic risk is the opposite of nonsystematic (unsystematic) risk, which is specific to one company or industry — a failed product launch, a lawsuit, poor management. Nonsystematic risk can be diversified away by holding many different securities. Distinguishing the two is the classic exam question: if diversification fixes it, it's nonsystematic; if it doesn't, it's systematic.

The SIE, Series 6, Series 7, and Series 65 exams all test systematic risk, usually by asking you to classify a risk as systematic or nonsystematic, or to recognize that a diversified portfolio still carries market risk. Hedging with options or other instruments — not diversification — is the way to reduce systematic risk.