Understanding Market and Asset Risk: A Guide to Smarter Investing

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Intrinsic market risk, often referred to as systemic risk, is the risk associated with the market as a whole rather than just a specific segment, asset, or investment. This type of risk stems from factors that influence the economic environment and its stability as a whole. Some examples of this include interest rates, current global events, and politics.

For investors, intrinsic market risk means that regardless of the research and return prediction behind an investment, nothing can be risk-free, not even the US Treasury Bonds (widely accepted as the most risk-free asset). There is great importance in taking into account the conditions of the market as a whole when making short and long-term investment decisions to better analyze the performance of your asset and its expected future value.

Various circumstances can amplify or lower intrinsic market risk depending on how they affect general confidence in the market. Market risk is raised when there is uncertainty in economic indicators like GDP growth rates, inflation, and unemployment. Even small shifts and changes in these sectors of the economy could prompt new government and economic policy that could quickly change the flow of the market. Contrastingly, when there is long-term economic expansion and positive market trends with no foresight of significant changes, the market seemingly becomes less risky because there is more confidence in returns on investment.

Separate from the market as a whole, individual investments also possess their own unique risks, which are combined with intrinsic market risk to create an overall risk profile for a specific asset. For example, a stock in the technology sector may have high volatility due to exacerbated market valuations for companies in the sector. These high valuations bank on the idea that technology will continue to dominate the global economy for the future, but any new changes can quickly undermine this theory and cause the stocks to fluctuate significantly. Similarly to intrinsic market risk, individual asset risk depends primarily on the confidence of investors in that sector. If they believe the asset's potential return outweighs its potential loss, then they will invest. The scale and proportion of the potential return to the potential loss dictates the riskiness of the asset for the investor.

When evaluating the risk of a particular asset, it is important to compare it to other options to see if it is justified. Some assets typically safer than the stock market are traditional savings accounts and other liquid investments. Savings accounts typically offer lower returns but come with minimal risk, which benefits investors that want to ensure asset security. On the other hand, assets with higher potential returns, such as stocks or real estate, come with greater risk exposure and are owned by higher-risk investors.

Of course, a balance between low-risk and high-risk investments is necessary to preserve wealth and have future potential growth, but depending on market conditions and intrinsic market risk, one type of investment may have a better return on risk ratio. For instance, during a stable economic period, investors may find the risk of investing in equities justified by the potential for significant returns and the weak returns on savings accounts. However, in times of market instability, the security liquid assets may outweigh the potential gains from riskier investments.

The risk-return trade-off along with the sector of an asset are some of the most important elements in the decision-making process for investors. With the outline of investment decisions above, it allows investors that are wary of market risk to make investments that not only give an expected return but also help stabilize the market. The different strategies of investors can greatly influence the composition of an investment portfolio, which may also influence the portfolio’s risk depending on the diversification of assets.

One present example of geopolitics affecting intrinsic market risk is the 2024 U.S. presidential election. Political uncertainty often leads to heightened market volatility, since various candidates may promote different economic goals and potential policy changes. If investors perceive a candidate's economic platform as destabilizing or extreme, investment decisions may become drastic and could substantially change the market. Since there is no certainty in the market until after new policy has been introduced, hesitant trading, liquid assets, and bonds may become more economical investments. Types of changes to economic policy could affect various sectors in the US markets without changing overall market risk. For example, higher corporate taxes for tech companies could lead to a decrease in tech stock prices but would not change the stability of other sectors like energy, retail, and real estate.

Overall, understanding the ways intrinsic market risk and individual asset risk interact with each other helps the investor make smarter decisions when obtaining assets. These decisions create a strong base in an investment portfolio that can be used to maximize potential gains and minimize potential losses. Although risk is always present, approaching it in an analytical way can improve investing in any form.

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