How does systematic risk differ from unsystematic risk?

Systematic risk refers to the inherent risk that affects the entire market or a broad segment of the market, which stems from external factors that cannot be avoided or diversified away, such as economic recessions, political instability, changes in interest rates, and natural disasters. This type of risk impacts all securities in the market, causing their prices to move in the same direction, given that it is related to macroeconomic factors.

In contrast, unsystematic risk is specific to a particular company or industry. It can arise due to events like management changes, product recalls, or competitive pressures that do not influence the broader market or other sectors in the same manner.

Thus, the distinction between these two types of risk is that systematic risk is prevalent across all securities, while unsystematic risk pertains to individual entities or their specific circumstances. This understanding is crucial for portfolio management and risk assessment, as it guides investors on how to mitigate risk through diversification, predominantly targeting unsystematic risks while accepting systematic risk as an unavoidable aspect of investing.