Once you know how much a particular portfolio might fluctuate, then you can assess whether it's the right fit for you. Of course, many new investors think that they can stomach big losses, only to find that they hit the panic button as soon as the market begins to tank. "People can intellectualize one thing," says Mr. Solin. "But in 2008, when markets were down 40 percent, my phone was ringing."
In his latest book, "The Smartest Portfolio You'll Ever Own," Solin sets out five portfolios for various levels of risk tolerance. His low-risk portfolio, with only 20 percent in stocks, lost just under 5 percent in the market massacre of 2008. His high-risk portfolio, with everything invested in stocks, lost 40 percent. If you can't stand losing 40 percent of the value of your nest egg in a single year, then you shouldn't invest all your money in stocks, he says. If you can't stand a 5 percent decline, you shouldn't be in stocks at all.
Knowing how long you plan to hold the portfolio before taking out substantial money also helps determine acceptable risk. The shorter your time horizon, the less risk you can afford to take, because it sometimes takes stocks many years to recover losses.
