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What is Unsystematic Risk?

Unsystematic risk is idiosyncratic or unique risk that does not reflect a direct correlation with the risk present in the market, or systematic risk.

Most securities and portfolios experience risk and variations which are not attributable to the market as a whole, and this is known as unsystematic risk. Systematic risk, on the other hand, is the risk borne by all investors in the market, where broad changes in the market cannot be avoided through diversification of a portfolio.

Unsystematic risk, theoretically, can be diversified away. The more diversification a portfolio has, the closer its beta will be to 1, meaning it will have a closer and closer correlation with the risk of the market as a whole.

Due to the risk-return tradeoff, some unsystematic or additional risk must be taken on beyond the market risk if an investor seeks to outperform the market.

Keywords: Beta, correlation, market risk, diversifiable risk, residual risk, systematic risk, risk return tradeoff, Diversification Score®, unsystematic risk,