Which type of risk can be mitigated through diversification?

Specific risk, also known as unsystematic risk, is the type of risk that can be mitigated through diversification. This risk is associated with individual assets or groups of assets and stems from factors unique to a company or industry, such as management decisions, competitive positioning, and operational performance.

By holding a well-diversified portfolio, an investor can reduce exposure to these specific risks. For instance, if one company experiences poor performance due to internal issues, that negative impact may be offset by the performance of other companies within the portfolio that are not affected by the same factors. Thus, diversification spreads risk across different assets, minimizing the potential negative impact of any single asset’s poor performance on the overall portfolio.

In contrast, market risk, systematic risk, and operational risk cannot be effectively mitigated through diversification alone. Market risk and systematic risk are tied to the broader market and economic factors that affect all investments to some degree, while operational risk pertains to failures in internal processes or systems, which cannot be diversified away by simply holding different investments.