How can investors calculate their risk tolerance?
If you're unsure how much money you can have invested, try the Rule of 100 subtract your age from 100, and the difference is the approximate percentage of your portfolio that may be appropriate for higher-risk investments. Remember, though, that this is just a rule of thumb, not a hard and fast standard. Also consider how strong your stomach is and how much you are actually willing to lose. Even if your time line to retirement says you could invest more, if you aren't willing to take the risk, then don't subject yourself to volatile investments.
How can investors protect themselves from the economic environment?
First, create an investment plan that identifies your financial goals and limits. A well-researched strategy can put you on the path toward achieving your investment objectives. When building your portfolio, be sure it's both diversified as well as incorporates a number of different investment vehicles the better diversified a portfolio, the more protected it is from significant losses. Don't put all of your eggs in the stock market basket, and be sure that some of your savings and investments are protected and positioned to withstand any market dip.
What should investors do to limit their exposure to risk but still take part in the upside potential?
Every investor is different. What one person considers "risky" another may consider conservative but there are financial products that are considered less risky than individual stocks. Funds such as mutual funds or exchange-traded funds are comprised of multiple investments; the goal is to diversify within the product itself so the investor is exposed to less volatility. Other ways to participate in the upside are through market-linked products such as market-linked CDs, life insurance or fixed indexed annuities. These financial products are typically considered "safer" than stocks, mutual funds or ETFs (Exchange Traded Funds) because the principal is usually protected. The earnings of the product are linked to a market exchange and interest is credited to the account based on market performance. However, there are some downsides to these investments. Typically your money is invested for a specific period of time, and in some cases you do not get to lock in all of the upside. The appropriateness of these products will depend on your financial situation. Sean P. Lee, retirement coach