Before you begin evaluating your risk tolerance, become familiar with the types of risk. The first risk many investors think of is market volatility. The price of an investment will rise or fall in response to changing market conditions. Some investments fluctuate in value more dramatically than others. For example, stocks tend to be more volatile than bonds.
Cash equivalents are generally the least volatile.
Risk to Principal. As the market price of an investment fluctuates, your amount invested can go up or down. Principal is also directly affected by credit risk. Credit risk relates to the strength of the entity issuing the security and its ability to repay its obligations. This type of risk applies directly to bonds and the possibility that the bond's issuer will not pay your principal or interest when due.