There are millions of different investments you can buy, and they all require you to consider the same key trade-off: risk versus return.

In general, the greater the potential return on your investment, the more likely it is to decline significantly in value. When you’re looking to maximize your portfolio’s return, ask yourself: What would a big drop in my investments do to me?

The question requires a multifaceted answer—one that examines how a decline in your portfolio would materially affect your finances and how you react emotionally to losing money.

Many investors have been able to answer this question of late. The broader stock market fell nearly 24% between January and mid-June, and many individual stocks and more volatile assets, such as cryptocurrencies, fared much worse.

If the recent market volatility has hurt a little more than you thought, consider taking a moment for some introspection, says Christine Benz, director of personal finance and retirement planning at Morningstar.

“A lot of people got into the market in 2020 and 2021 simply because it was going up,” Benz tells CNBC Make It. “Now is a good time to take a deep breath, step back and think about what is the right amount of risk to take in your portfolio.”

Here’s how to make sure you’re investing with the right level of risk, according to market experts.

Understanding risk capacity and risk tolerance

Back to the main question: What would a large drop in the value of your portfolio do to you?

First, a drop in your portfolio would materially affect the rest of your financial picture. This is called your risk capacity. If you’re years away from a long-term goal, such as retirement, short-term dips in your portfolio aren’t necessarily a big deal because your investments have decades to recover.

However, if your goal is in the near future, a big loss can ruin your plans. For example, if you had part of your portfolio earmarked for a down payment on a home this year, you may not be able to afford a 24% drop.

Second, how would a big loss in your wallet make you feel? The answer is, of course, bad – but how bad? “Gloomily checking your brokerage account every morning” bad or “selling every investment you own in a complete panic” bad?

Investment professionals call your ability to stick to your financial plan in the face of investment losses as your risk tolerance. It’s okay to panic when big red numbers start flooding your portfolio page, says Brad Klontz, a certified financial planner and professor of financial psychology at Creighton University. But if you let that panic push you into rash financial decisions, you can do real damage to your finances, Klontz says.

“Who doesn’t panic? If you’re on a roller coaster going down and your stomach is flipping, that’s normal,” he says. The problem arises when it “makes you want to jump off the ride or never ride a roller coaster again.”

How to take the right amount of risk

If the recent market swings haven’t affected your financial plans, then your only next steps are to stay the course. But if you’ve deviated from your plans or never had a plan in the first place, it’s time to get your wallet on track.

Start with your risk capacity, suggests Benz: “Consider what you’re trying to achieve and your proximity to when you need the money. You may need sub-portfolios for different purposes.”

In general, young people saving for retirement can invest that portion of their portfolio primarily in a broad group of stocks, Benz says. They offer higher long-term returns than other types of assets, but also tend to come with more risk.

For short- or medium-term goals that are one to three years, “consider adding safer assets like cash, short-term bond funds and U.S. government bond funds,” says Benz. From there, she adds, consider how you’ll react to future losses: “Risk capacity doesn’t matter if you’re going to overturn your well-laid plan when you’re uncomfortable with the losses you’ve suffered in a short time. – deadline.”

Many online questionnaires can help you determine your risk tolerance. Examining your behavior during the last downturn can be an equally useful gauge, experts say.

“If I feel uncomfortable in this kind of up-and-down market, I need to remember that and put protections in place so I don’t feel that way next time,” says Kelly LaVigne, vice president of consumer insights. at Allianz Life. “Because it will happen again. And you’ll feel bad again.”

To avoid the kind of panic you may have felt in the first half of the year, consider reducing your allocations to riskier assets like stocks and cryptocurrencies. You may also want to consider investing in a fund that manages the allocations for you.

“An all-in-one fund, such as a target date fund, can help take you out of the equation and let the product do the heavy lifting,” says Benz.

A financial advisor may be able to help on that front as well, says Levine: “The biggest thing is to make sure you don’t follow your gut and pull out of the market until you talk to someone who can help you with allocation yours.”

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