• 19th July 2024

Knowing the difference between the systemic and systematic risks

If someone asked you the difference between systemic and systematic, how would you answer? Generally, the term systematic refers to something that is based on a system or method. It can also be a habitual behavior resulting from a system, regardless of whether it is intentional. On the other hand, systemic refers to something that happens inside the system and affects every inch of the system. Did you know that we also have these terms in market and finance?

Systemic and systematic risks

Systematic risk is the daily and continuous risk that happens because of many reasons. It can be because of the economy, interest rates, politics, and many more. It is the extensive and never-ending market risks that reflect a lot of problematic factors. On the other hand, we have systemic risks. It refers to an occurrence that created a massive collapse in a particular industry or a broader economy. Hence it is a company- or an industry- level. While they are both dangers to the markets and economy, they have their differences. Hence there are different ways to manage them, and we should be aware of how to do that.

First, we have systemic risk.

Systemic risk is about an entity’s complete failure, and risks played a significant role in what happened. This entity may be as small as a business to something as massive as the whole economy. It can also involve sectors, industries, institutions, and more. We can describe this risk as something small and specific, like bank account flaws. However, it can also be described as something as big as an economic crisis.

People who are not too knowledgeable about financial markets and the economy think about a specific health problem inside a person’s body when you say the systemic. It makes sense to believe that what once was a minor health problem can lead to the deterioration or death of a person. We can compare this to risk, regardless of its size, dramatically impacting the whole economy. 

We also have systematic risk.

While more people are familiar with the term systematic than systemic, many people confuse this with “market risk.” Systematic risk refers to a problem that might occur in the market as a whole, and it will take more than merely portfolio or holding diversification to resolve it. Systematic risks are challenging to solve, even with various asset allocation strategies. However, they are still manageable. It will take more than diversification to fix the problem.

On the other hand, market risks are involved with recessions, wars, stagnant interest rates, volatility in currencies/ commodity prices, and more massive issues than you can imagine. Under market risks, we have “idiosyncratic risks” that refer to those specific to industries and firms and are still salvageable. The risks that involve systematic are more extensive than this. Hence, a more complex and step-by-step plan is needed to solve the issues.

The risks we face to gain

There are countless times that systematic risks proved that they are more quantifiable, and it is possible to make anticipations. However, this is, unfortunately, harder to do with systemic risks. An investor who wishes to avoid systematic risks should put various asset classes in his portfolio so that they will all behave differently during a significant systemic change.

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