Final answer:
Diversifiable risk is the potential for loss in a specific company or industry due to unique factors. It can be mitigated by spreading investments across a variety of sectors and assets, a strategy known as diversification, which mutual funds commonly employ.
Step-by-step explanation:
Diversifiable risk, also known as unsystematic risk, firm-specific risk, or company-unique risk, refers to the potential for an investor to experience losses due to factors that can affect the performance of a specific company or industry. This kind of risk is inherent in each individual company and is not tied to the broader movements of the financial markets.
Unfavorable events like poor management decisions, product recalls, or legal challenges are examples of diversifiable risks. Investors can mitigate these risks through diversification, which involves spreading investments across various sectors and financial instruments to reduce the exposure to any single asset or company.
Mutual funds are a common tool for achieving diversification. By pooling money from many investors, mutual funds can invest in a wider range of companies, which helps individual investors to diversify their holdings more easily than if they were to try and build a diverse portfolio on their own. This strategy aligns with the aphorism 'Don't put all your eggs in one basket', meaning it helps protect against significant financial loss should any one investment perform poorly.