There are two fundamental risks that go along with investing; systematic risk and unsystematic risk. Unlike systematic risk, unsystematic risk only affects a small portion of shareholders. It is typically company or industry specific and has to do with unforeseen events like strikes or loss of a key account. Luckily, there are a number of ways to reduce the impact unsystematic risk will have on your portfolio. Consider the following when building your investment portfolio:
- The best way to reduce unsystematic risk is to diversify your portfolio. This means investing in a number of companies instead of putting all of your eggs in one basket. This way, if something unforeseen does happen to affect the stock price in a particular company, you have other investments in your portfolio to fall back on.
- When diversifying your portfolio, your investments should be in more one than one industry. If you limit your investments to one industry you could find all of your stocks losing money if an industry-wide unsystematic risk happens.
- There is a formula to help determine unsystematic risk. First, you should find the beta coefficient for your investment. You can do this through online investment services. You should then choose what percent of your investments to place in a particular stock. Quick tip: the lower the beta coefficient the less you have to worry about unsystematic risk. After you have decided what percent of your investments to place in a particular stock, follow this formula to determine overall beta and resulting risks:
- Beta (total) = Percentage of overall investment x beta coefficient.
- You can also cater the above formula to determine the systematic risk of more than one company at a time as seen through the following formula:
- Beta (total) = Percentage of first overall investment x first beta coefficient + Percentage of second overall investment x second beta coefficient.
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