This is the time of year when we often make bad food and drink choices, ones we regret the morning after, when we wake up with a pounding head… and a few pounds heavier. So too do investors make bad stock decisions on a regular basis. Many investors treat the stock market like a gambling pit. But, as stated aptly in a funny line early on in the movie, The Hangover, “It’s not gambling when you know what you are doing.”

Indeed, the biggest form of risk investors take is not related to the stock market at all – rather it is a function of what they know (and more specifically what they don’t know). The traditional definition of risk in the stock market is volatility – how much the market is moving up and down. By that definition, the stock market has been very risky lately. But is that truly a good definition of risk within investing? Here are some alternatives for consideration as you enter the New Year and face daily choices about how to invest your hard earned money.

1) The best definition of taking risks, in my opinion and as noted above, is not knowing what you are doing. A knife in the hands of a child poses danger; the same knife in the palm of a skilled surgeon can save lives.

2) Risk is owning too much of the same thing. Microsoft can be a great investment, but if you are Bill Gates and that is your primary holding, selling some (as he has done over the years) and diversifying can be beneficial. Just think of all the poor souls who had their entire retirement plan in company stocks like GM, Enron, and more recently American Airlines (which just went bankrupt.)

3) Risk is not matching your investments with your time horizon. Need the money tomorrow? Keep it in cash. Need it in 10 years? Then cash is your enemy – you should be invested in a diverse portfolio of stocks and bonds. If you are investing in stocks for retirement 10 or 20 years hence, why are daily ups and downs in the short term a form of risk at all rather than just noise?

4) Risk is buying a bad stock or overpaying for a good one. When you are at that cocktail party over the holidays, resist taking action on the latest stock‘tip’ from your friends or co-workers. Most of them turn out to be dogs with fleas. Even good companies can be bad stocks if you overpay for them (think of companies like Corning that still make good profits today, but which are trading at a fraction of their internet bubble highs). This is true of any asset class, as many learned the hard way with real estate in the 2000’s. Pay more for anything than it is worth, and you will have a difficult time finding someone who will buy it from you at an even higher price. Being disciplined about the quality and price of the securities you buy will materially reduce the risks you are taking in the stock market.

It is difficult to avoid daily headlines of bleak economic news. It seems like the global financial system is one drink away from passing out and falling down the proverbial stairs. But the truth is…such financial, political, and other (e.g. terrorist) challenges have always been present, and still the world economy and US stock market persevere. You should view the stock market for what it is: not a Vegas casino, but rather a mechanism for building long-term wealth via smart and rational investment decisions. Here’s to a healthy and prosperous 2012.

(The information in this article is strictly for educational and illustrative purposes and is not an attempt to furnish personalized investment advice or services.)