Systematic and non-systematic risks: how to mitigate risks

The business world is always at risk. Understanding these risks allows us to find the most effective way to mitigate these risks. What are these risks? How to classify?

There are two main components of risk: systemic and non-systematic. Let us explore each risk and learn the best way to mitigate it.

Systemic risk
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Systemic risk, also known as "market risk" or "non-distributable risk", is the result of external and uncontrollable variables that are not industry- or safety-specific. Usually inevitable, it affects the entire market, causing price fluctuations in all securities. The risks can be attributed to a wide range of economic factors such as inflation, interest rate movements, currency fluctuations, and economic recessions.

Because systemic risks are beyond control, investors can avoid these risks by staying away from all venture capital.

Financial Planning - Mitigating Systemic Risk
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Certain action plans can mitigate systemic risks. How can we alleviate them?

Asset allocation can partially mitigate systemic risks. Having different or zero-related different asset classes [ie bonds, cash, commodities, etc.] is helpful because they have different effects on macroeconomic factors; some asset classes may increase, and

Asset allocation should also be adjusted based on valuation. Undervalued investments should be avoided or reduced. When it comes to reducing systemic risk in a diversified portfolio, cash is probably the most important and under-recognized asset class.

Another way to reduce systemic risk is through hedging. Investors can use options such as purchasing protective securities. Protective put options are risk management strategies that investors use to guard against unrealized gains. If the value of the security falls, the value of the sale will rise. However, the option is for a period of time and once it expires, the investor needs to purchase a new one to maintain hedging.

Non-systematic risk
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In contrast, non-systematic risk refers to risk factors specific to the company, industry and sector, and can be controlled to some extent. These factors include company management, financial practices, financial status, and competitive position in the market.

Financial Planning - Reducing non-systematic risks
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Diversification can reduce non-systemic risks. To achieve this goal, investors can diversify their product portfolio so that revenues depend not only on a small number of products. When an investor's risk spreads between different industries [such as banking or healthcare] and asset classes, the risk is greatly reduced. For example, if an investor has a diversified portfolio of more than 10 separate investments instead of just one, then when some companies have a negative impact, the damage to their portfolio will be minimized.

Similarly, diversification can almost eliminate non-systematic risks because it has nothing to do with market risk.

Both systematic and non-systematic risks are an important part of the business. Through the above risk management solutions, these risks can be partially mitigated, and investors will be able to see an increase in portfolio returns and optimization of the portfolio.

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