Ask The Expert
Dear Brett,
I have several alerts set up but I rarely see any alerts get triggered. I think I am setting them up correctly. Can you help me?
F.C.,
MN
What is Market Capitalization?
Systematic & Nonsystematic Risk
The various risks you take as an investor can be broadly categorized as either systematic or nonsystematic.
Systematic risk, or market risk, is characteristic of the entire market or a particular market segment. Because the market is inherently unpredictable, systematic risk always exists. There is always the chance that the entire market or a particular market segment will experience an economic downturn.
A strategic use of asset allocation can help limit systematic risk. For example, in the bond market, when interest rates rise, the value of previously issued bonds decreases, thereby decreasing their relative value compared with bonds currently selling in the market. When this happens, new investors will be attracted to the bond market because of the higher rates. However, the popularity of the bond market has a negative affect on the stock market, as investors tend to leave stocks for bonds, where they can get a strong return with lower risk.
However, when the opposite happens as it inevitably does and interest rates drop, investors tend to put money into stocks for their higher potential returns, driving stock prices up.
To take advantage of this regular pattern of market ups and downs, allocating percentages of your portfolio to both of these asset classes - and others - can help counter the negative effects of a decline in one asset class and let you take advantage of gains in the other.
While asset allocation helps mitigate systematic risk, diversification can help alleviate nonsystematic risk. Nonsystematic risk is based on unpredictable factors, like poor management decisions within a company or the introduction of competitive products. Since nonsystematic risk is based on the performance of an individual company or groups of companies, diversifying your portfolio by investing in a variety of companies within each asset class or in mutual funds within that class can help counteract nonsystematic risk. Diversification into more than one company, or in a mutual fund, can help protect a portfolio against the adverse effects of one single company's failure.
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