What Investors Need to Know About Investment Risk
At its core, investment risk is the probability or likelihood of losses relative to the expected return on an investment. In essence, it is the degree of uncertainty about the return on an investment. It's important to understand that all investments carry some level of risk, and it is directly proportional to returns – the higher the potential returns, the higher the risk.
Types of Risk
There are several kinds of risk that investors must be aware of. Here are some of the more common ones:
- Market risk: The risk arising from fluctuations in the market. It is also known as systematic risk and affects all investments in the market.
- Credit risk: The risk that a debtor will not repay their loans, resulting in a loss for the investor.
- Liquidity risk: This risk arises when an investor cannot buy or sell investments quickly enough in the market without affecting the asset's value.
- Inflation risk: Also known as purchasing power risk, it is the potential for inflation to undermine an investment's returns through eroding its value.
Risk Analysis: The Process
Risk analysis is the process of identifying and assessing potential losses for investments. It involves quantitative and qualitative methods:
- Quantitative risk analysis: This kind of analysis involves numerical and statistical techniques to calculate risk. It includes investment data analysis, cash flow analysis, and probability distributions.
- Qualitative risk analysis: This type of analysis assesses risk based on experience, expert knowledge, and other non-numerical factors. It includes identifying potential risk sources, evaluating their impact, and creating strategies to manage them.
How Financial Professionals Assess Investment Risk
Investment risk analysis is employed to understand an investor's risk tolerance and, subsequently, to tailor the investment strategy. The primary step in this analytical process is risk assessment. During a risk assessment, investors complete questionnaires or interviews that aim to help determine:
- Their capacity to bear financial loss.
- Investment goals
- Time horizon for investing
- Overall comfort with different levels of risk.
Next, professionals consider the investor's financial position by evaluating:
- Financial health - Examine their income, net worth, existing investment portfolio, and liquidity needs to provide a clearer picture of the level of risk the investor can comfortably handle.
- Market conditions - Market conditions can significantly impact an investor's capacity or willingness to bear risk. For instance, during volatile market periods, even investors with a high tolerance for risk may want to adopt more conservative strategies.
- Age and investment time frame - Generally, younger investors can afford to take more risk because they have more time to recuperate from potential losses, making them suitable for long-term, high-risk investments.
After a risk analysis, financial professionals assign a tolerance:
- High Risk Tolerance (Aggressive): Investors are willing to accept the possibility of losing money in exchange for the potential of higher returns.
- Moderate Risk Tolerance (Balanced): Investors are ready for some losses, but they prefer a mix of small and large gains.
- Low Risk Tolerance (Conservative): Investors prefer lower returns to avoid potential losses.
It's essential to note that an investor's risk tolerance can change over time, due to personal circumstances, making continued risk analysis necessary. Risk analysis is crucial for investors for the following reasons:
- Objective decision-making - Risk analysis provides an objective way to assess the potential risks associated with an investment, helping avoid emotional or biased decisions.
- Risk mitigation - By identifying and understanding potential risks, investors can take steps to mitigate them, such as diversifying their portfolios, implementing stop-loss orders, or choosing investments that align with their risk tolerance. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
- Profit maximization - A thorough risk analysis can help investors to maximize profits and minimize losses. It provides insight into the potential downside of an investment, enabling investors and their financial professionals to anticipate and plan for possible losses.
- Increased confidence - With a clear understanding of the risks involved, investors may be more confident in their investment decisions, making the investment process less stressful.
Let's Team Up
Risk and investment performance are two sides of the same coin. As an investor, it's vital to understand the risks involved and how risk analysis can help make informed, strategic decisions. A comprehensive risk analysis can provide an investor with a clear picture of potential risks and the tools to mitigate them, enhancing their capacity to maximize returns and minimize losses.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG, LLC, is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.
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After three blockbuster years for the S&P 500, investors are questioning whether there’s any more room to run. The good news is that earnings growth, not multiple expansion, is increasingly fueling the bull market. The share of S&P 500 returns driven by earnings growth rose from just 27% in 2023 to 84% in 2025. Consensus is calling for an even stronger 2026, with EPS growth estimates sitting around 15%. But here too, investors are skeptical. This is over 3x consensus for nominal GDP growth, manufacturing activity is weak and consumer sentiment is at rock bottom.
But the areas of the market driving earnings growth aren’t tethered to the traditional economy. As this week’s chart shows, the technology sectors are expected to contribute 60% of the EPS growth in 2026. While the AI buildout is boosting economic growth, it’s through capital, not labor. The typical data center project creates less than 100 jobs per billion dollars invested versus over a thousand for traditional manufacturing plants of a similar price. The other area driving EPS growth is the financials sector, and this too is a capital story. Corporate IPO & M&A activity and stock market performance are boosting investment banking and asset management fees, respectively.
So, while earnings growth and the market are very much on track for another strong year, their results aren’t likely to support the labor market or the median consumer. The middle 60% of Americans still make up the majority of consumption, which is still the majority of the economy. Investors need to be mindful of this increasingly fragile expansion. Exposure to U.S. innovators is critical but hedge economic and political uncertainty by diversifying abroad.
Chart of the Week: Source: FactSet, Standard & Poor's, J.P. Morgan Asset Management.
Thought of the Week: Source: Bloomberg, FactSet, Standard & Poor's, J.P. Morgan Asset Management.
Index: Institute for Supply Management Manufacturing Index; PCE: Personal consumption expenditures; Philly Fed Survey: Philadelphia Fed Business Outlook Survey; PMI: Purchasing Managers' Manufacturing Index; PPI: Producer Price Index; SAAR: Seasonally
Adjusted Annual Rate
MSCI EAFE is a Morgan Stanley Capital International Index that is designed to measure the performance of the developed stock markets of Europe, Australasia, and the Far East.
Bond Returns: All returns represent total return. Index: Bloomberg US Aggregate; provided by: Bloomberg Capital. Index: Bloomberg Investment Grade Credit; provided by: Bloomberg Capital. Index: Bloomberg Municipal Bond 10 Yr; provided by: Blomberg Capital. Index: Bloomberg Capital High Yield Index; provided by: Bloomberg Capital.
Key Interest Rates: 2 Year Treasury, FactSet; 10 Year Treasury, FactSet; 30 Year Treasury, FactSet; 10 Year German Bund, FactSet. 3 Month LIBOR, British Bankers’ Association; 3 Month EURIBOR, European Banking Federation; 6 Month CD, Federal Reserve; 30 Year Mortgage, Mortgage Bankers Association (MBA); Prime Rate: Federal Reserve.
Commodities: Gold, FactSet; Crude Oil (WTI), FactSet; Gasoline, FactSet; Natural Gas, FactSet; Silver, FactSet; Copper, FactSet; Corn, FactSet. Bloomberg Commodity Index (BBG Idx), Bloomberg Finance L.P.
information from FactSet's Pricing database as provided by MSCI. Russell 1000 Value Index,
Style Returns: Style box returns based on Russell Indexes with the exception of the Large-Cap Blend box, which reflects the S&P 500 Index. All values are cumulative total return for stated period including the reinvestment of dividends. The Index used from L to R,
top to bottomare: Russell 1000 Value Index (Measures the performance of those Russell 1000 companies with lower price-to book ratios and lower forecasted growth values), S&P 500 Index (Index represents the 500 Large Cap portion of the stockmarket, and
is comprised of 500 stocks as selected by the S&P Index Committee), Russell 1000 Growth Index (Measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values), Russell Mid Cap Value Index (Measures
the performance of those Russell Mid Cap companies with lower price-to-book ratios and lower forecasted growth values), Russell Mid Cap Index (The Russell Midcap Index includes the smallest 800 securities in the Russell 1000), Russell Mid Cap Growth Index (Measures the performance of those Russell Mid Cap companies with higher price-to-book ratios and higher forecasted growth values), Russell 2000 Value Index (Measures the performance of those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values), Russell 2000 Index (The Russell 2000 includes the smallest 2000 securities in the Russell 3000), Russell 2000 Growth Index (Measures the performance of those Russell
2000 companies with higher price-to-book ratios and higher forecasted growth values).
Past performance does not guarantee future results.
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