 Systematic risk versus unsystematic risk. What does it mean? Ladies and gentlemen, on today's episode, we're gonna talk about systematic risk versus unsystematic risk, why it's important. Now, the thing about it, we all know with any investment, you're always gonna have to deal with risk. And when you deal with risk, ladies and gentlemen, you know that when you invest, well, you're gonna have to have some type of risk, but not all risks are the same. Some risks can be diversified away from, versus some risks cannot be diversified away from. So in this episode, we're gonna talk about unsystematic risk and systematic risk. First, we're gonna start off with systematic risk. We're gonna talk about what it is, ways to diversify away from it. We're not systematic, but unsystematic, we will. But we're gonna start off with systematic risk. Then we're gonna get into unsystematic risk. We're gonna give you examples of each, and then we're gonna talk about in the unsystematic way, how you can diversify away from it. Why is this invest important to investments? Because sometimes with investments, I used to always think, oh, you got to risk something in order to make something. But sometimes there's something called dumb risk, and risk you don't have to take, and risk that you can mitigate, right? So what I need further to do, ladies and gentlemen, let's go ahead and jump straight into it. So systematic risk, when you look at your systematic risks, these are risks that cannot be diversified away from. This is kind of like sort of thing of just the price of doing business. So for prime example, you use the acronym called PRIME, which is P-R-I-N-E, PRIME, right? P-R-I-N-E. So the first one is purchase and power, inflation. Purchase and power is considered inflation, right? When you look at purchase and power, purchase and power is the ability to be able to buy something in the future. For prime example, you have $100 a day. Think about how many, if you go to Walmart and you brought groceries for $100, look how much stuff you could have got into a shopping cart. Versus if you take that same $100 and you went back to 1995 or 1980 with that same $100, you probably will be able to purchase more things. So over time, the same amount of money is purchasing less and less. This is considered purchasing power risk, something that you can't diversify away from. Inflation risk is another one that people are to say is something that you cannot diversify away from. It's just part of doing business. It's a systematic risk. The next one, the R, is reinvestment risk. So for prime example, I own Coca-Cola stock. Coca-Cola stock pays a dividend. I don't know when Coca-Cola stock is gonna pay a dividend, dividends are not guaranteed, but it can reinvest at a great time or a bad time. You don't know. So when you reinvest your money or you have your dividends reinvested, you don't know when they're gonna be reinvested. That's just a risk that you just take in doing business. The next one is called interest rate risk, the I. The P was purchasing power. The R was reinvestment. The I is interest rate risk. We don't know what interest rates are gonna be. It's always quoted with Warren Buffett saying that if he had any inkling of what interest rates, if he had any information that he can know in the future, it would be interest rates. That's the most powerful thing. We don't know what interest rates are gonna be. Are interest rates gonna rise or interest rates gonna fall? Right now, interest rates are at a very, very low. Who controls the interest rates? Who controls the interest rates is the Fed share. This is the Fed share is Jerome Powell. The I, which is interest rate. The interest rate risk is the risk that interest rates will change in the future. Interest rates going up and when you're a bond holder and you have interest rates going up, what happens, right? As interest rates increase and you're a bond holder, that's not good, right? Versus when interest rates are dropping, bond rates, right? So you have, for prime example, look at the people who own a house. For right now, you've seen a lot of people refinance and people have an ability to refinance because interest rates continue to drop. And every time the economy starts to take a decline, part of the stimulus package is to lower interest rates. So we don't know what interest rates are gonna be in the future. Are they gonna be higher or are they gonna be lower? Because if I do interest rates are gonna be lower in the future, I may be interested in just an interest rate loan. Versus since I don't know what interest rates are gonna be, I pick a fixed interest rate. So interest rates control the price that we get on cars, the price we get on credit cards, all sorts of things, right? The next one is market risk. When you're investing, you have to deal with market risk. We don't know what the market is gonna do. You know, you see the market take, who would it guess last year in 2020 that we'll have seen a big pandemic hit in the market take a decline? We didn't know this information, right? So since we didn't know this information, this makes it extremely, it's a risk that we can't diversify away from. The next one is exchange rate risk. Exchange rate risk, we don't know what currencies are gonna be exchanging for. Prince, why do I care about exchange rate risk? Most of your top companies in America are doing business overseas. So for prime example, if you make, let's say if you're selling a product in pesos in Mexico, you earn, let's say Nike earns a lot of money, let's say a thousand dollars in pesos, not a thousand dollars in pesos, let's say they earn a thousand pesos. A thousand pesos, what does that convert to in dollars? The exchange rate risk is always changing. We don't know. As the dollar gets stronger, other currencies have a tendency to get weaker, and as the other currency get weaker, the dollar has a tendency to get strong. So you don't know if the dollar's gonna be strong in the future or weaker in the future. That's an exchange rate risk. Prime, P-R-I-N-E, purchase power, reinvestment, interest rates, market, and exchange. You can't diversify away from that. Now we're gonna get into unsystematic risk. Unsystematic risk is a risk that you can diversify away from, that you can limit. Now, I don't have a pretty acronym for unsystematic, but we're gonna go through some of the unsystematic risk. Now, political risk. When you look at political risk, the political risk is you look at a country like Venezuela, or you look at Detroit, Michigan, or you look at Orange County, California. Detroit, Michigan defaulted on this debt. Venezuela, we don't know what's going on over there. The inflation rate is through the roof. And you look at Orange County. Orange County is a company, not a company, but not a company, but let me take that back. That's a different type of risk. Let's stay with international. When you invest in international, you have a political risk. And what I mean by that, let's take a country like Venezuela or let's take a country like China. We all know last year, the topic of discussion before the pandemic hit was everybody was all concerned about trade wars, tariffs, tariffs getting raised. President Trump wakes up. He says, hey, I'm gonna put a tariff on Chinese oil. I'm just hypothetically speaking. But he will raise tariffs at any time. So that means that any time a country, whatever they are imported into our country, their price just increased. When you're looking at that, that's a risk that you take when you invest overseas. Political risk. Let's say over in China or a country like Iran or something like that, what a government could be overthrown. Just could just wake up one day and say, hey, we want our president out of office. We don't want you to be our president anymore. They can't overthrow the government. That's considered a political risk, ladies and gentlemen. So when you invest overseas, when you invest in international, that's the political risk. But the good news is that this is unsystematic, right? Unsystematic meaning that you can diversify away from this sort of risk. How can you diversify away from this sort of risk? This type of risk is not investing overseas or diversifying your portfolio, not only having all your money with one company, but putting your money into other companies, right? So with that being said, hey, don't put all your money into China. You can put some of your money in America and China or spread it between Asian companies, European companies, things like that. You can diversify away from political risk by investing into different countries, right? The most solid crazy that may seem to some people, the most solid political country is America, right? So now the next one you have is business risk, business risk, the risk of just doing business. What's an example of this? Just think about it. Who would have thought in 2019, as we were celebrating New Year's, that we would see companies like California pieces that would disappear? Who would have took the bet last year that Zoom would be worth more money than all the airlines combined, market cap-wise speaking, right? We've seen Zoom become a primary company over airlines. Airlines, as everybody know, the travel industry has been taking very hard, take a massive hit, but who would have took that bet last year? Who would have took the bet that restaurants would be having a hard time this year? Many people would have never saw that coming. Who would have had an airborne pandemic that would pretty much derail our economy here in America? Many people wouldn't have took that risk. Ladies and gentlemen, that's the risk of just doing business. You do not know who would have known that restaurants, who would have known that, you were talking about 20 years ago, who would have known that phones would just take over the world? That people would be watching movies via phones. So by the business risk, people back then, people said, hey, guess what, Prince? We're always gonna drive vehicles. We're always gonna need oil, news flash. Now we're moving more and more to electronic vehicles. 23 years ago, people said, Prince, we're always gonna watch movies. Blockbusters would be a great investment. Movie theaters would be a great investment. It was 20, 30 years ago. Who would have thought that people would be sitting at home on the confere of their home, watching movies online via the internet, or via their phone? We're still watching movies, but the way we're watching movies are totally different. Look at companies like Uber and Lyft that just came out and made a big name for themselves, ladies and gentlemen. This itself is business risk, the risk of doing business. You just don't know what's gonna happen when you're doing business. The next risk, but you can diversify away from business risk by putting your money into different sectors. For prime example, you may have money to the technology sector. You may have money to a real estate. You may have money into a real estate. You may have something to energy. You may have money, energy, real estate, groceries and things like that. So think about it. We're always gonna consume groceries. We're always gonna eat food. But who would have thought it would have been buying our food via our phone? So this itself is how you can diversify from business risk by diversifying via sectors. As you see, companies like Zoom has had a great year. Companies like Airlines have been struggling. Travel industry has struggled. But if you are diversified, you can diversify away from business risk. So first we talked about political risk and how to diversify away from it. Then we just discussed business risk and how to diversify away from it. The next one is called financial risk. Financial risk, most people do not know what financial risk is because it's under my opinion, believe about 95 to 98% of investors do not know how to refinance reports or refinance reports. I won't say don't know how to read. Most people who buy stocks, they consider researchers by talking to a couple of friends and family, looking up a couple of articles online and say, hey, I know this company. I've done research. How many people have looked at the 10K report, the 10Q report, looked at the liabilities of the company, knows the total debt of the company, knows the equity ratio, the asset to liability, know what the network of the company is, shareholders equity, most people do not know that. So financial risk is taking on a lot of debt and being able to pay it back and grow your business. Some companies are experiencing a lot of growth from borrowing a lot of money, much money. So that requires you to know the debt equity ratio and in order to know the debt equity ratio, you probably, unless you've got some type of software, that requires you to open up a 10K report, a 10Q report, something that most financial, most people that invest don't do. Professionals know this or should know this, that you should be able to look at financial risk. So a company, me borrowing a lot of money to start a company, yes, my company is growing, I'm doing a lot of great things, but my ability to be able to pay that money back is a financial risk when you're dealing away with that. That risk can be diversified away from by knowing companies, knowing doing your research and knowing companies that have a large, knowing their cash to equity ratio, knowing that debt to equity ratio, knowing the ability, being able to evaluate the company's ability to pay away, pay away of his debt. So for prime example, if I know a company has a million dollars in cash, but also I know the debt is only $100,000, I can say, hey, this company, it has enough current assets to be able to pay off this long-term debt at any time. That's my ability to be able to get away from financial risk or diversify away from financial risk. The next one, these kind of go hand-in-hand, default and credit risk. So when you purchase a bond, you're essentially purchasing debt from a corporation. It's an IOU from a corporation. So you have corporate bonds, you have government bonds, you have cities issue bonds, you have municipal bonds, but it's pretty much my corporation is saying that, hey, let me borrow $1,000 and I'm gonna pay you back with interest in the future. That's all a corporate bond is. So when you look at a corporate bond, when you look at a corporate bond, that's pretty much what it is. So a corporate bond is fine. They're saying, hey, let me borrow $1,000 and I'll pay you back in five years and I'm gonna give you 4% over five years. Sounds like a pretty good deal. I invest $1,000 and I wanna make, that's about what, $40 or whatnot over the next five years. Oh, pretty cool deal. The deal is great until unless that company defaults mean the company goes bankrupt. Going back to the companies, the entities that I mentioned earlier, looking at Detroit, Detroit defaulted on $600 million worth of bonds back in 2013, if I'm not mistaken. So that itself, a bond, that's the default risk. Somebody, you let somebody borrow money and they lose their job. They don't have any income. They default on their loans. Default or a credit risk. The credit risk is that the person you lend money to can't pay you back. The bank let me money to purchase my car. I'm making a car notes, I'll find a Danny until I can't pay back the bank. That's when it becomes an issue. That's a default and a credit risk. How can that be diversified away from? That can be diversified away from reading the, knowing the, all bonds, just like I have a credit score, individuals have a credit score. So does corporations. You have bonds that have, looking up the, if it's a grade A bond, triple A bond, triple B bond, there are different grades for bonds. So the great ability that the company can pay back is debt, the less interest is going to pay and the greater score the bond is going to be. But by doing due diligence, you can diversify away from that by investing into different types of bonds. Not buying just only corporate bonds, but you could buy corporate bonds, followed by government bonds, followed by long-term bonds, short-term bonds. You can buy different turns of bonds. So if the city, if you have a bunch of muni bonds, municinal bonds, let's say the city of the Baltimore debt, that all your money is not tied up into a city, you can diversify between grades and also different types of bonds. That's how credit and default risk can be diversified away from. The next one is event risk. Event risk, who remembers the BP oil spill? Remember, we just woke up one day, BP oil just spilled a bunch of oil in the middle of the ocean and nobody knew what happened and BP oil started to crash and everybody questioned all the fracking and oil prices started to rise. That's an event. You just can't help. Just like the pandemic just came out of the blue and hit the market and something like that would happen again and again, but it's a black swan event. So how can you stop this from happening? How can you prevent this from happening? You can't prevent it from happening. What you're gonna be able to do, you can diversify away. For prime example, if you had a company like BP that experienced a very hard time, what I mean by experienced a very hard time that had an oil event, had a big event that happened, if you're diversified into other entities of different companies, your money's not tied in the one place. So you can diversify from an event. A event, we don't know when it's gonna happen. It's a risk. Who knows? Reputation, tomorrow they could come out and say, hey, Coca-Cola has been still in money and take a big reputational blow hit that can drop the stop. You don't know what can happen, but to stop that from happening, you can diversify across the board. All right? Now, that's the risk. We just spoke about systematic risk before earlier. The systematic risk is risk that you just, it's just a risk of investing. You really can't diversify away from that. We use the acronym PRIME, P-R-I-M-E. P being purchasing power, R being reinvestment risk, I being interest rate risk, and M being market risk, and E being exchange rate risk. You just can't really diversify away from them. That's just a part of doing business. Now we talked about unsystematic risk. Unsystematic risk is risk that you can diversify away from. We talked about political risk. You can diversify away from political risk by spreading your money across different countries. So for PRIME example, some countries can be overthrown, so you don't put all your money into one particular, one particular country. Now another way I like to diversify away from political risk is, you diversify away from political risk due to their ability to, what you call it, due to your ability to, you can find something that both Republicans and Democrats agree upon that's domesticated. So a country accompanying for PRIME example that's here in California, that both Republicans and Democrats agree upon for PRIME example, I can limit my political risk on airline stocks because both Republicans and Democrats believe that airlines should get a second round bailout. So since both of them agree upon it, that limits my risk of one just jumping up out of the blue and saying no, or whatever the case may be. That's just an example I'm using hypothetically. Another one, business risk. You'd have the risk of just doing business. Who would have known that restaurants would have, who would have known that drive thrills would become more popular and state houses would have a big issue in 2020. Who would have took that bet in 2019? Not that many people, but things happen. Who would have took the bet that Zoom would be worth more than all the major airlines could buy? That's just a part of doing business. Now you look at the risk of financial risk. The risk, you have a financial risk, the risk that the country company would be able to pay back his money. These are all unsystematic things. We talked about default and credit. We talked about event risk and one risk I forgot, liquidity risk. Liquidity risk is a risk, unsystematic risk. Liquidity is a risk of you being able to convert your investment into cash in a short amount of time. For prime example, I have an emergency. My water heater just went out. I need to, I need this cash right now so I can pay somebody to come out here, replace my water heater. Now, if my money is tied up into a, let's say Coca-Cola stock, I have to sell the stock, then I have to wait till the money clears, then I have to transfer, wait till it gets in my account. That's liquidity. Or if I took my cash and I put it inside of a home, I brought a house or I brought a rental property or I brought a piece of land, how long would it take to put a land that I own? How long would it take for that land to convert to cash? That's liquidity risk. So how fast can your money convert to cash that can be used to pay debt or to buy inventory to become an accounts receivable to become a profit? So that's liquidity risk. Any event risk we talked about, we don't know what can happen at any time. Well, let's talk about ways to diversify from liquidity risk is, hey, have some of your money in a savings account, have some money in a money market account, maybe have some in a bond, some in a stock or whatnot. So don't have all your money tied up into long-term investments. That's a liquidity risk. Event risk is the event that anything can happen at any time, like BP or can just, a major oil spill can just happen at any time. You diversify away from that by buying different sectors. Well, ladies and gentlemen, that's gonna conclude today's topic. I hope you guys and girls took something away from it. It was a very top, a very, I would say, complex episode for me today. Had a couple of technical difficulties, but I'm glad I was able to get in here and get this taken care of for you guys and girls, guys and girls across the globe. We talked about systematic risk, unsystematic risk, risk you can't diversify away from, versus risk that you can diversify away from. I hope you took something away from it. Until the next video, podcast, cartoon, book, or whatever else crazy you see me doing around the globe, peace, be safe, I'm out and thank you.