There are always risks in the business world. Understanding its risks enables us to find the most effective way to minimize it. What are these risks and how can they be classified?
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There are two main components of risk: systematic and non -systematic. Let’s examine each risk and figure out the best way to mitigate it.
Systematic risk, also known as “market risk” or “non -specific risk”, is a result of external and uncontrollable variables, that are not industry -specific or security -specific. In general inevitably, this has affected the entire market primarily with fluctuations in the prices of all securities. The risk can be attributed to many economic factors such as inflation, interest rate fluctuations, currency fluctuations, recession, etc.
Since systematic risks are unavoidable, investors can avoid them by avoiding all risk investing.
Financial Planning- Reducing System Risk
Systematic risks can be mitigated with specific courses of action. How can they be relieved?
Allocating assets can be part of reducing systematic risks. Owning different categories of assets (i.e. bonds, cash, commodities, etc.) with little or zero correlation is helpful because they differ in terms of macroeconomic factors; some asset categories may be added and others may fall.
The offer of assets should also be adjusted according to the estimates. Overpriced investments should be avoided or owned sparingly. If systematic risks are minimized within a variety of portfolios, money becomes a more important and unrecognized category of assets.
Another way to reduce systematic risk is through hedging. Investors can use options such as buying hedges placed on their securities. A safeguard is the risk management strategy used by investors to guard against the loss of unknown earnings. The deposit amount will be set if the value of the securities falls. However, the options are for a specific time and when they expire, investors will have to buy new ones to stay hedged.
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Not System Risk
In contrast, unsystematic risk refers to risk factors that are specific to a company, industry and sector, and can be controlled to a degree. These factors include the management of a company, financial procedures, financial health, and its competitive position in the market.
Financial Planning- Risk Reduction
Unsystematic risk can be minimized by diversification. To achieve this, the investor can divide its product portfolio so the profits don’t just depend from just a few products. Much risk is reduced when investor risk is spread between different industries (such as banking or healthcare) and asset classes. For example, if an investor invests in a diversified portfolio of more than 10 individual investments as opposed to one, the damage done to their portfolio will be less if something negative happens to certain companies.
Again, non-risk risk can be almost eliminated by diversification because it is not related to market risk.
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Both systematic and non -systematic risks are part and parcel of businesses. Through risk management solutions as mentioned above, these risks can be reduced to a minimum, and investors can see increased portfolio return and optimization of the investment portfolio.