LET'S START THIS section with a simple, multiple-choice question:
You have saved for a big vacation. Two weeks before your departure, you lose your job. Do you:
a. Cancel your vacation?
b. Make plans for a modest vacation at the beach instead?
c. Go as scheduled, reasoning that job hunting will go better after a good vacation?
d. Extend your vacation and plan a real blowout; this might be your last opportunity to go first-class?
What's this got to do with investing? We were wondering the same thing after we read it on another personal-finance site. It's part of a fairly typical interactive quiz titled, "How Much Risk Can You Handle?" The quiz aims, it seems, to gauge your capacity for terror rather than the common hazards of investing. Another question begins this way: "You invest $10,000 in a stock that drops 10% the next day ..." You can almost hear Jack Nicholson in the background: "You want risk? You can't handle risk."
Risk is a fact of life for any investor. Stock markets plunge. Companies go bankrupt. And there are countless other little ways to lose money much less dramatically. There's even risk in doing nothing: Thanks to inflation, $100 left moldering in the bank (earning no interest) will be worth about $75 in 10 years. To earn the highest rewards, you have to assume a certain amount of risk. To minimize your exposure to the dangers of investing, you have to accept lower returns.
But the truth is, you can probably handle a lot more risk than you think. You simply have to recognize the dangers that exist and learn some easy strategies to protect yourself. Investing is a time-tested way to make money, not a game. Think of it this way: If the stock market were so treacherous, how come so many people have done so well?
Rather than scare you, we'd like to get you comfortable with the idea that "risk tolerance" has more to do with time than temperament: As our interactive Time vs. Risk section will explain, the more time you've got to make up for short-term losses, the more aggressive you can be with your investments.
We'd also encourage you to take a walk through our Stock Market Chamber of Horrors. It will demonstrate how some of the market's worst disasters could have been prevented simply by being patient, thinking defensively and not exposing yourself foolishly. When you're done, check out our Defense Is the Best Offense section for information on how risk-limiting strategies like asset allocation, diversification and dollar-cost averaging work.
