There are many definitions of risk, but the definition I’ve found that most closely aligns with investing and risk management is that risk is the potential for deviation from an expected result, whether the deviation is a positive or negative result. Managing investment risks, by extension, is the analytical process that measures the potential for deviation to better enable decision-making on what risk to pursue, mitigate or avoid. Risk and return go together, and every investment decision carries an element of risk, which is why a practical understanding of financial theory can assist investment decision-making.

There are many risk factors that could give rise to market risk, including: geopolitical risk, monetary and fiscal policy, changes in interest rates and foreign exchange rates, terrorist events, and natural disasters. The need to understand market risk has grown as the operating environment has become more volatile and this volatility has increased the potential for large, frequent and unexpected asset price swings, consequently regulators have increased expectations for banks to develop extreme but plausible scenarios for their modeling framework, but investors also need to consider how volatility catalysts could impact their portfolios, and many brokerage firms have built capabilities that enable investors to stress test their portfolios.

Asking what the market did today is a common question, but in this case the market is really referencing a single equity index, which is usually the S&P 500. While the S&P 500 is a significant index it is only a single index within an economy that has multiple markets, and each market operates in different ways. A market, by definition, is a trading place where a buyer and seller exchange goods and services, and it could be a physical market or an online market. Because the definition is so broad, the balance of this article addresses financial markets: equity markets, debt markets, derivative markets and money markets.

Perhaps the single most important question an investor can ask himself or herself is “what is my investment objective”. The answer to that question serves as the basis underpinning investment decisions and investment objectives can change over time. Let’s take a look at investment objectives for a specific individual’s 401K and over time.

Accounting is the language of business, and financial statements summarize the various underlying accounting entries. Accounting, especially through financial statements, allows us to understand a business and make better investment decisions, but it also allows us to improve our personal financial lives.

Liquidity, cash flow and capital play critical roles in ensuring firm solvency, especially during stress scenarios like the 2008 recession, and supporting the growth and performance of a firm. The three terms are often used interchangeably, but they are distinct and serve different purposes for firms. Firms have become insolvent because of inadequate capital, liquidity and/or cash flow, not only causing loss of shareholder value but also shaking confidence in the stability of the financial system.

Cognitive biases and emotions work in concert to influence our decisions, thus we need to be aware of both and deploy mechanisms to mitigate negative influences. Similarly, investors need to be aware of how firms also deploy mechanisms that mitigate biases and emotions within firms when making decisions, because it is the sum of these decisions that determines if firms, and our investments, succeed or potentially fail.