What type of risk is avoidable through diversification?

Diversification is a key strategy in investment management that aims to reduce risk by spreading investments across various asset classes, sectors, or geographic regions. The type of risk that can be effectively mitigated through diversification is unsystematic risk.

Unsystematic risk, also known as specific or idiosyncratic risk, is the risk associated with individual assets or a small group of assets. This risk stems from factors like company performance, management decisions, product recalls, and other events that influence a particular entity. Since this risk is tied to particular investments, diversifying a portfolio can help neutralize its impact. By holding a wide range of investments, negative events affecting one asset can be offset by positive performance in others.

In contrast, systematic risk refers to market-wide risks that cannot be eliminated through diversification. This includes factors such as economic downturns, interest rate changes, or geopolitical events that affect all assets in a similar manner. Other forms of risk, such as market risk and interest rate risk, are also systematic since they impact the market as a whole and cannot be diversified away.

Therefore, the correct answer accurately identifies the risk that is avoidable through diversification, highlighting the importance of building a diversified portfolio to manage investment risks effectively.