Diversifiable risk, also known as unsystematic risk, refers to the uncertainty associated with investing in a specific company or industry. This type of risk can be reduced through diversification, which means investing in a variety of assets to spread the risk. If an investor holds a portfolio of different investments, the negative performance of one investment could potentially be offset by the positive performance of another. Therefore, a diversified portfolio could minimize the potential negative impact on an investor’s overall portfolio.
Related Questions
1. What is non-diversifiable risk?
Non-diversifiable risk, also known as systematic risk or market risk, is associated with the whole market or the broad economy. It is the part of the risk that cannot be eliminated just by adding various stocks or securities into the portfolio. Examples include interest rate changes, inflation, political instability, or natural disasters.
2. How to effectively reduce diversifiable risk?
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To effectively reduce diversifiable risk, an investor can diversify their portfolio. This involves investing in different assets such as stocks, bonds, and commodities from various industries and companies. The key objective is to spread the investment across different asset classes to reduce the impact of poor performance from any one investment.
3. Why is diversifiable risk considered to be avoidable?
Diversifiable risk is considered avoidable because it’s typically related to individual companies or sectors. Therefore, a savvy investor can reduce the potential impact of this risk on their portfolio by diversifying their investments across various industries and asset classes, thus avoiding putting all of their eggs in one basket.
4. What are examples of diversifiable risk?
Examples of diversifiable risk include business risk, which is associated with the operations of an individual company, and financial risk, which relates to how a company is financed. Other examples include credit risk (the chance that a borrower will not repay a loan) and liquidity risk (the risk that an investment may not be easy to sell quickly at a fair price).
5. What is the difference between diversifiable risk and non-diversifiable risk?
The main difference between diversifiable risk and non-diversifiable risk lies in their nature and how they can be mitigated. Diversifiable risk is specific to a company or an industry, and can be reduced through diversification. Non-diversifiable risk, on the other hand, affects the entire market or economy and cannot be mitigated just by holding a diverse portfolio. Irrespective of the number of stocks in the portfolio, this risk cannot be eliminated.