Unsystematic risk.

In plain English

Unsystematic risk comes from things specific to a single business or sector, such as a product recall, a lawsuit, a failed trial, or a management change. Because these events hit one name and not the whole market, holding many unrelated positions lets the surprises offset each other. As the number of independent holdings rises, this component of risk shrinks toward zero, with most of the benefit arriving in the first few dozen names. Markets do not pay investors extra for carrying risk that could have been diversified away for free. What is left after diversification is systematic risk.

01Why it matters

Holding a large single-stock position means bearing risk the market does not compensate, so the extra volatility comes with no matching increase in expected return.

02The math, step by step

A portfolio holds one stock and it falls 40 percent on a failed product launch, so the portfolio falls 40 percent. Hold that same stock as 1 of 40 equal positions and the same event costs the portfolio 1 percent. The company news was identical; the exposure was not.

Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.

03What this is NOT

04Receipts

Every figure on this page is sourced to a primary document. Tap to open the original.