What is your tolerance for risk?

If you had a 100% chance of winning $8,000 or an 80% chance of winning $10,000, which would you choose? If you had a 100% chance of losing $8,000 or an 80% chance of losing $10,000 and a 20% chance of losing nothing, which would you choose?

One of these days, the stock market is going to quit setting record highs and fall back for a while. By how far and for how long is anybody's guess.

The Dow-Jones Average has not suffered a 10% "correction" since 1990. That is a long time. A 10% correction in today's market would be roughly 700 points. Many investors in today's market never have seen a 10% correction. What would you do if the market dropped 700 points -- or more? Panic and sell? Take a deep breath and buy? Hold tight? What would you do if there were a repeat of the 1973-74 bear market when stocks lost 45% of their value in just under two years? Could you weather that?

These are variations of a single question: What is your tolerance for investment risk? First, of course, you need to define the term. All investments have risk, even certificates of deposit, which generally won't lose the money you put in them because they are government insured, but they can earn less than what taxes and inflation eat away. Stocks usually stay ahead of taxes and inflation, but there is always the short-term risk of loss of principal. So, what is investment risk to you: loss of principal, inability to maintain a standard of living, failure to meet the investment goals you set?

Now let's return to the opening questions. Studies have shown that most people choose the 100% chance in question one and the 80% chance in question two. In other words, they hate loss more than they love gain -- even though the alternative choices in both questions actually are superior risks.

One financial planning firm likes to ask clients the following: "Would you rather be out of the stock market when it goes down than in the market...