Globalization
In our interconnected global world, computer dysfunction can greatly disrupt our daily lives. Our lives are connected through nearly every device we use, and even more so through voice commands or gestures!
In a previous post, I mentioned that using voice commands for timers or hand gestures to control the TV has become the norm for many at home. Even our fridges can automatically order more groceries when we’re low. So, what happens when the computers we interact with daily and depend on stop working?
Real Life Example
We saw this in real time recently. A global IT outage on July 19, 2024, caused by a faulty update from cybersecurity firm CrowdStrike, resulted in widespread disruptions across various sectors. The outage impacted Microsoft platforms, particularly its Azure cloud computing service, which is used by a vast number of businesses and organizations worldwide, including 95% of Fortune 500 companies. The disruptions affected airlines, banks, media outlets, government agencies, and healthcare facilities, among many others. The outage led to grounded flights, delays in financial transactions, and the cancellation of appointments.
When we can’t conduct our normal activities/work while that ‘blue screen of death’ is still visible, what do we do? In the hospital setting, we had pop-up command centers, backup on backup, and downtime procedures in place that would jump into action, allowing for minimal disruption.
This was the vendor’s view. What about the consumer’s view? If this impact puts a hold on your investments or prevents you from accessing your bank accounts for an important transaction, it could place you in a precarious situation. In most cases, investors or consumers don’t have a backup plan for this type of impact, hence the risk.
Systematic Risk
In investing talk, Systematic risk is the inherent risk that an investor takes by investing in the market. This could be the impact of the failure of a global security update, internet failure, NYSE crash, or power disruption, along with any factor that can be linked to the broad market over any individual investment. Systematic risk, in a nutshell, is the risk of investing in the market as a whole. This can be internal or externally linked. Another name for systematic risk, and likely easier to remember, is Market risk. Calculating Systematic risk can be done by taking the portfolio standard deviation and subtracting the portfolio unsystematic risk (wait, that’s a number?!- Yup, Read on!).
Unsystematic Risk
On the other hand, unsystematic risk is the risk associated with the individual security or investment. This is the risk that most investors think of when putting their money in the market. “How will a security/investment perform?” is always a great question, but remember, risk is defined as a range. It is always +/- (Plus or minus) a value. Though it’s almost comical to consider positive risk, we almost inherently consider risk negative. If you’d like a further description of this, read this article I wrote: It’s a Risky Business, or is it?.
Unsystematic risk can be calculated by taking the Standard deviation of the portfolio minus the portfolio beta.
High Yield take away – the elusive alpha, is found within the unsystematic risk (we’ll discuss this in-depth on a later day)
‘Smart beta’ strategies – leverage ‘styles or factors’ to find alpha in the unsystematic risk (more on this as well, in a future post) of a portfolio
Total Risk
As mentioned in the post linked above, total risk is the summation of systematic risk and unsystematic risk. It is also the portfolio's standard deviation.
Total risk = standard deviation of the portfolio (all subsequent equations are assumed at the portfolio)
Standard deviation = Unsystematic risk + Systematic risk
Systematic risk = Standard deviation - unsystematic risk
Unsystematic risk = Standard Deviation – systematic risk
Why is it so complicated?
Well, it is risky business, isn’t it?!
All great puns aside, understanding risk is complicated. The varying degree of risk tolerance, ability to take risk, along with the understanding of risk makes for a story with many twists and turns. This is precisely why I always recommend having a teacher at your side. Our team of financial advisors at Whitaker Myers Wealth Managers knows and understands all aspects of risk. Even more so, our team will walk with you through each phase of your journey to align your investments with your risk tolerance at that phase. Schedule time to chat with one of our advisors to learn more!
Systematic and Unsystematic Risk Factors
July 29, 2024
Summit Puri
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