Comfort with risk refers to how you feel about market volatility. Specifically, how will you respond when investment values decline unexpectedly? Will you fret over losses and sell your holdings to prevent further decline? Or can you remain calm and stick to your investment strategy?

Gauging your comfort with risk is tough for 2 reasons. Feelings about money and investing are subjective and difficult to quantify. Also, predictions about future behavior are rarely 100% accurate..

Objectivity in the face of emotions

An investment strategy can be tailored to achieve an "appropriate" level of risk. These decisions are generally based on a few hard facts such as:

• Your investment goal
• Your time frame
• The availability of money to handle emergencies

However, objective criteria alone ignore the swirl of emotions influencing our attitudes about money and investing. And gut feelings sometimes overshadow objective criteria when making decisions.

Investment anxiety and optimism

Skydivers can point to hours of training and a backup parachute as ways they reduce the risks inherent in their sport. But for most people, these objective facts will never outweigh the emotional apprehension they feel about jumping out of a plane.

Generally, feelings about money and investing are more difficult to gauge than those about something like skydiving. Yes, anxiety about possibly losing money could prevent a person from ever starting an investment plan. More often, however, people start investing without seriously considering their emotions surrounding money and investing, which can be problematic if investments don't perform exactly as anticipated.

In many ways, we humans are hard-wired for optimism. And as a result, most of us don't really expect to lose money when we invest. Sure, we know the potential for loss exists, but the tendency is to believe we'll make money.

Consequently, our true comfort with risk isn't known until we're faced with declining investment values. We may find ourselves surprised, nervous or even outright scared in the face of market volatility. And these emotions can lead to poor investment decisions.

Examining your attitudes

To avoid a situation where you respond emotionally, try to honestly assess your financial feelings and factor them into your investment planning.

Evaluating your comfort with risk doesn't involve trying to change your feelings about money through logic or reasoning. The goal is to honestly identify them to help predict how you might respond to volatility or losses.

Learning from your past. One way to start digging into the relevant emotions is to consider how you've previously handled setbacks or losses. These could be from any part of your life, including:

• A close friend's moving to another state
• A promotion you wanted but didn't get
• The loss of a job

You might also want to ask yourself some questions specifically related to money and investing.

• Does the thought of losing money worry you?
• Is a reliable rate of return more appealing than a 50-50 shot at a much higher return?
• What were your parents' attitudes about money when you were a child?

Using what you've learned

Tell your financial advisor what you've learned about yourself and your comfort with risk. Together, you can weigh this information against objective investment criteria as you look to balance risk and return potential through diversification and asset allocation.

The right amount of risk in your investments can give you the confidence to stick to your investment strategy even when the market takes an unexpected dip. But if you start feeling nervous or uncomfortable about your investments, be cautious about how you respond.

A knee-jerk response based on emotions can cause you to sell when prices are low, rather than hold onto an investment that has the potential to rebound and erase paper losses.

The bottom line

American culture often celebrates risk. As a result, we're practically conditioned to embrace it. But taking on more risk than you're comfortable with can be dangerous for an investor. It's important to examine your attitudes and understand your risk tolerance before you invest.