Can You Handle the Investment Risk?

As entrepreneurs, we pride ourselves on being risk-takers. But when it comes to investing, we tend to be protective of the money we've worked so hard for. That's why, when the Dow Jones industrial average plunged 22.1 percent in eight trading sessions last October to its lowest level in five years, even the bravest investors started dumping shares and fleeing to the safety of cash.

The reality is that no investment--not even a blue chip company like GM or IBM--is 100 percent safe, and investors who put their money in the market, hoping to average an 8 percent to 10 percent return, risk losing their entire investment if the market goes south and the company files for bankruptcy. Unfortunately, investors who panic when the market collapses, hoping to jump back in when the market rebounds, generally end up losing their initial investment as well as the opportunity for upside. Trying to time the market is a surefire way to watch your nest egg shrink to zero.

So while nobody likes volatility, you need to establish an investment strategy that sees you through good times and bad. The first step is to assess your personal tolerance for investment risk. Are you young and single with no kids and 40 years to go until retirement? Or are you married with teenagers approaching college and aging parents who need your help? Do you need your investments to generate an income stream until your business is more established, or does your business kick off excess cash you can add to your investment account every month?

Finally, how much money are you willing to lose in the short term if the financial markets take another nose dive? "You may have a very different sense of the risks you're willing to take in building the private equity of your business vs. those you're willing to take with liquid investments over which you have no control," says Kenneth Shapiro, a Merrill Lynch wealth management advisor and former entrepreneur who helps entrepreneurs develop financial strategies that integrate their personal and business goals. "Similarly, your tolerance for investment risk can vary based on how much financial security you've already created for yourself through monetizing a portion of your business's equity."

So before you make a decision you'll regret, consult with an investment advisor about your long- and short-term financial objectives and create a plan that provides the potential for capital appreciation and income generation but also lets you sleep at night. Whether that means risking all your money in the stock market or stashing some of it in cash and government bonds, the key is to match your investment strategy to your personality as an investor.

Want to check out your own tolerance for investment risk? Take The New York Institute of Finance's free quiz.

The information contained herein is provided for informational purposes only and should not be relied upon in making investment decisions. Before investing, you should always consult with a licensed investment professional. Past performance of investments discussed in this column is not an indication or guarantee of future performance.