Imagine, one day, you're keeping an eye on your investments, feeling good about their steady growth. Then the next day, out of the blue, a major news story breaks and bam – the value of your investment starts jumping around. Weird, right? Especially when what you see in the news seems unrelated to your investments.

Welcome to the world of systematic risk. For both the new and seasoned investors, systematic risk can throw a real curveball. And you often don't see it coming.

So, let's unpack systematic risk together, bit by bit. This article will walk you through what systematic risk is all about, turning the complex into something you can grasp and navigate through your investing journey.

What is systematic risk?

Systematic risk can have a big impact on your investments. But not everyone knows about or understands systematic risk, especially if you've just started investing.

Imagine you’ve got a nice little garden ( your shares portfolio ), and you’ve done everything right. You’ve planted different types of plants (that’s diversification), watered them, and made sure they get plenty of sun. But then, a huge storm hits the whole area and does some damage to your garden.

That’s systematic risk – it’s like a big, unexpected storm that can affect the whole financial market, not just your investment portfolio.

Now, systematic risk is also called 'undiversifiable risk'. That means it's tough to avoid it completely, even with a well-diversified portfolio. It's an ongoing risk, something that's always there, lurking in the background. You can manage systematic risk (more on that later) but you can't avoid it completely. Major events, like the Great Recession or the collapse of major banks (think Lehman Brothers and the Global Financial Crisis), are examples of systematic risks causing big waves.

Here's where it gets interesting for investors like me and you. Systematic risk is ongoing. This means that big-picture issues and macroeconomic events – stuff happening on a huge scale – can have a ripple effect. Even an exogenous shock, which is a fancy term for a big surprise event that no-one saw coming, can jolt the market.

Now, when we talk about different types of systematic risk, there are a few key players:

1. Market risk: This risk refers to the general mood of market participants. Think of stock markets like the ASX or any big stock exchange. If the overall market dives, it can pull down commodity prices, including those cybersecurity stocks you thought were doing great.
2. Interest rate risk: This is about the cost of borrowing money. When a central bank of a country (like the Reserve Bank of Australia) changes interest rates, it can ripple through the financial world. This change can affect everything from your home loan to the value of stocks and bonds.
3. Recession risk: A recession is when the broader economy is slowing down over some time, and people spend less. This can hit companies hard, reducing their profits and the value of their shares.
4. Inflation risk: Inflation is when the cost of living goes up. When prices rise, the buying power of money goes down, which can hurt investments.
5. Currency risk: This undiversifiable risk type is important if you're investing overseas. Changes in exchange rates can affect the value of your foreign investments when you convert them back to your home currency.
6. Sovereign risk: This is related to countries and their ability to pay back their debts. If a country is struggling financially, it can affect the value of its currency and its ability to support its financial system.

But don't worry, systematic risk isn't all doom and gloom. It's about being aware and prepared, also known as risk management. Systematic risk is a bit like weather for your investments – you can't control it, but understanding it helps you prepare better.

How is it different to specific risk?

Many investors can get systematic risk and specific risk (also known as idiosyncratic risk) confused with each other. Investors might think a problem with a specific company will affect the whole market. On the other hand, they might not realise that a big economic change can impact even the best performing individual stocks or sectors.

But there are key differences between systematic risk and specific risks and knowing the difference will serve you well in your investing journey. Let's explore further.

	Systematic Risk	Specific Risk
What it impacts	The entire market or a broad segment of it.	Individual stocks, sectors, or companies.
Nature of risk	Undiversifiable risk. It's a risk inherent to the entire market and can't be avoided by diversification.	Diversifiable risk. You can manage this risk by spreading your investments across different stocks or sectors.
Trigger	Caused by macroeconomic events, big-picture issues, major changes in the broader economy (e.g. The Great Recession).	Often due to company-specific events (e.g. major company scandal) or sector-specific issues.
Control	Investors have little to no control over systematic risk. It's ongoing and perpetual. However, they can manage its impact.	Investors can reduce impact by not putting all their eggs in one basket (diversification).

Remember, understanding the difference between systematic risk and specific risk is a key aspect of risk management in investing.

Examples of systematic and specific risk

Let's make sense of systematic and specific risks in investing by looking at some real-life examples.

Systematic risk examples:

1. Great Recession: Remember the financial crisis around 2008? That's a classic example of systematic risk. Major banks, like Lehman Brothers, faced huge problems, which sent shockwaves through the global financial system. It was a massive, economy-wide issue.
2. Economic crisis: Say there's a big economic downturn in a country. This can lead to widespread issues in the financial markets, affecting stocks, bonds, and even the broader economy. It's like a domino effect; when one piece falls, others follow.
3. Major policy changes: When the Reserve Bank of Australia or any other central bank makes a big policy change, like adjusting interest rates significantly, it can impact the entire financial market. It affects how much it costs to borrow money, influencing everything from home loans to business investments.

Specific risk examples:

1. Corporate scandal: Imagine a big company you've invested in suddenly gets hit by a scandal. Maybe there's news about misleading conduct or some shady dealings. This situation would directly impact that company's stock, but not necessarily the whole market.
2. Sector-specific downturns: Think about stocks in the tourism industry. If there's a sudden drop in demand for travel, stocks in this sector might take a hit. But this doesn't mean all stocks or sectors will be affected in the same way.
3. Commodity price changes: Say you've invested in a company that relies heavily on a specific commodity such as wheat. If the price of wheat crashes (which you can monitor on the ASX website ), your investment could suffer. But again, this is specific to that industry and doesn't mean the entire market will fall.

Remember, in investing, systematic and specific risks are always present. By knowing the difference between the two, you can make smarter decisions about where to put your money. It's all about balancing and being prepared for both the big waves and the sudden bumps!

What factors influence systematic risk?

Just like weather affects everyone in town, systematic risk affects the whole financial market. It's made up of a bunch of different factors that can impact your investments. These factors may seem like a huge, tangled web that's hard to grasp, but let's break it down in a simple way.

1. The economy: When the economy is struggling, like during a recession, it can affect all kinds of investments. The economy plays a big role. The Great Recession is a classic example of this. It wasn't a single company or type of stock that took a hit; it was widespread.
2. Political and regulatory environment: When governments or bodies like the Reserve Bank of Australia change the rules (think taxes, trade policies, interest rates), it can stir up the waters for all market participants.
3. Technology changes: When new tech comes out, it can shake up the market. It can also change how industries work, affecting stocks and sectors, like how cybersecurity stocks are now in higher demand.
4. Natural disasters: These are unexpected and can cause big waves in the financial ocean, affecting everything from insurance companies to commodity prices.
5. Health crises: A global health crisis, like a pandemic, is an exogenous shock – an unexpected event that comes from outside the financial system but hits it hard.
6. Corporate health: The financial health of big companies, especially major banks, is also important. If a big bank has problems, it can affect many other segments of the market.
7. Market implosion or economic crisis: These are like tsunamis in the financial world. They're big events that affect almost everything and everyone in the market.

So, what does all this mean for you and your investments? Well, systematic risk will always be there, no matter where you are in your investing journey. But is there a way to manage systematic risk?

How can investors manage or minimise systematic risk?

Systematic risk is unpredictable and can happen at any time, which is what makes it challenging to navigate. As previously mentioned, systematic risk is also undiversifiable. This means you can't avoid it by just spreading your investments across different types, sectors or countries.

Sometimes, knowing these big risks exist can make people feel a bit helpless. This feeling can sometimes stop people from wanting to invest because it seems too risky or uncertain.

But, here's the good news: even though you can't avoid systematic risk completely, you can manage it. There are two key ways you can do that – through diversification and considering risk-adjusted returns.

Diversification

Diversification is a key strategy for managing systematic risk. Think of it as not putting all your eggs in one basket. Instead of investing all your money in one investment type, like just shares in tech companies, you spread it out.

You can invest in different asset classes or industries – like stocks, bonds, real estate, and even different countries' markets. This way, if one market or sector has a tough time, not all parts of your investment will be hit hard. It's about balancing your risks. And you can always consider changing positions in your portfolio as the market moves over time.

Risk-adjusted returns

Another important strategy is looking at risk-adjusted returns. This means when you look at an investment, you don't just consider how much money you might make from it; you also think about how risky it is. Some investments might offer high returns, but they also come with high risks.

Risk-adjusted returns help you compare investments by considering both the returns and the risks. It's like choosing a route for a road trip – you want to find the best balance between the fastest route and the safest one.

In terms of managing ongoing and perpetual market risks, these strategies are helpful. They don't eliminate the risk, but they can help reduce its impact on your investment portfolio.

By using these strategies, you're not blindly choosing investments. You're making informed choices based on a good understanding of both the potential rewards and the risks. This can help you feel more confident and secure in your investment journey, even when there are big-picture issues or major changes in the financial world.

What is systematic risk – a conclusion

Systematic risk can be like navigating through unknown waters in your investing journey. Remember, systematic risk is an ongoing risk, something that's always there. It changes over time and affects everyone.

But don't let this deter you. Knowing about systematic risk is a step toward achieving your investment goals. It helps you understand the bigger picture and how different factors, such as a recession, the health of major banks, or even global events can impact your investments.

The key is to manage systematic risks through smart strategies like diversification through your portfolio asset allocation – spreading your investments across different asset classes.

As you continue on your investing path, keep these lessons in mind. Stay informed, be flexible in changing positions when needed, and always consider the broader implications of your financial decisions.

Happy investing!