Retail participation in the U.S. stock market has grown rapidly across demographics. From 2023 through early 2025, individual investor funds into the stock market rose by approximately 50%, according to JPMorgan. Approaching the investing levels last seen during the pandemic. This momentum was further highlighted by a recent Reuters article titled “Retail investors to have more sway over Wall Street after a record year,” underscoring the growing influence of individual investors in 2025. This is driven in part by accessible trading platforms like Robinhood. As more people take control of their investment decisions, understanding risk becomes critical. In particular, investors must learn to distinguish between how much risk they are emotionally comfortable with and how much risk they can financially afford.
Robinhood is a fintech company that popularized commission-free and mobile investing. They provide an electronic trading platform that allows its user to invest in various asset classes. They are a digital brokerage firm that has grown rapidly over the past few years and are now comparable in size to Charles Schwab, a long-established company with a strong foothold in the industry. In 2025, they were one of the top five best-performing stocks in the S&P 500. As a company they have catered to “retail investors”, a term used to describe non-professional individuals who buy and sell securities for themselves.
This blog is not intended to criticize Robinhood or the services it provides. The company has introduced meaningful innovation to the investing space and has played a significant role in expanding market access for everyday investors through a simple, intuitive platform. However, as investing becomes more accessible and individuals take greater responsibility for their own financial decisions, the importance of understanding risk increases. This blog will focus on what risk truly means in the context of investing and how retail investors should think about risk when using the financial products available to them.
To start, investment risk is often measured by the degree to which an investment’s returns fluctuate over time. The wider the range of potential outcomes, the more volatile, and therefore riskier the investment is considered to be.
A simple way to think about risk is through a game. Imagine a coin flip where you either win and double your money or lose everything, there is no middle ground. Because the possible outcomes are so far apart, the level of uncertainty is very high, making this a risky bet. Investing works in a similar way, the wider the range of possible outcomes, the greater the risk. This is why it’s important for investors to understand the difference between their risk tolerance and their risk capacity.
Risk tolerance is how comfortable an individual is with the idea of being exposed to potentially losing money in the short-term to then earn a higher return in the long-run. Another way to think about it is in the question, Can I emotionally withstand this outcome? If you’re uncomfortable with the idea of an investment losing value, you would be considered an investor with a low risk tolerance.
Risk capacity refers to the amount of risk an individual can responsibly assume without jeopardizing their financial stability or long-term goals. Like in the example above, another way to think about this is, can I afford this outcome. Risk capacity is driven more by an individual’s financial situation than by their emotional ability to handle potential investment losses. Drivers for high risk tolerance are long time horizon, high income, and large wealth. These allow one to absorb losses from risky bets without affecting their overall financial health.
Take for example, a younger individual who has $100 to invest for retirement and won’t need to access that money for more than 20 years. With such a long-time horizon, they have a greater ability to withstand the short-term volatility that comes with investing. That $100 investment might drop to $80 in the first year and grow to $1,000 by year 10, what happens between years one and ten is largely irrelevant, as long as the investment is higher by the time it’s needed decades later.
Similarly, individuals with higher incomes or substantial amounts of wealth have a greater risk capacity because they have more ongoing cash flows and financial resources to rely on. Even if their investments experience short-term losses, they can continue to cover living expense and pursue long-term financial goals without disruption. This financial flexibility creates a buffer that allows them to absorb volatility without sacrificing their lifestyle.
As a result, someone with a high-risk tolerance does not necessarily have a high-risk capacity, and vice versa. This is why understanding the difference between the two can help when investing on your own.
As more retail investors gain access to increasingly sophisticated financial products, the gap between perceived risk and actual risk becomes more apparent. Instruments such as options, cryptocurrencies, and leveraged ETFs are now readily available on many trading platforms, often with limited explanation of their underlying mechanics. Many of these instruments share a common feature, the use of leverage. This became one of the dominant themes in the product management industry during 2025. While leverage can magnify returns, it also exponentially amplifies losses, sometimes faster than investors expect or can financially withstand.
Trading options, in particular, often appeals to investors with a high-risk tolerance due to their potential for outsized gains. However, the emotional comfort to withstand volatility does not necessarily equate to the financial capacity to absorb losses. Unlike stocks, which represent ownership in a company, options are financial derivatives, ownership in a contract with predefined characteristics set at creation and purchase. One of these defining characteristics is time sensitivity; options can expire worthless. As a result, even when an investor’s market outlook is correct, poor timing alone can lead to a total loss. While platforms have made investing easier and more accessible, they have not reduced the inherent risks of the complex products available to trade.
As retail participation continues to grow, it essential to understand how different investment tools align with both your own risk tolerance and risk capacity. As trading platforms continue to make investing more accessible, that doesn’t eliminate the inherent risk involved. The importance of understanding how and investment works and how it may impact long-term financial goals is critical. Speaking with a qualified financial advisor can help clarify both your risk tolerance and risk capacity, ensuring your investment decisions are informed and aligned with your broader financial plan.
Sources:
https://www.reuters.com/markets/us/retail-replaces-smart-money-wall-street-rocket-fuel-2025-07-29