The statistics are very clear: Maintaining a large allocation to stocks has allowed investors to build considerable wealth. Behavioral finance is also very clear: The typical human has emotional and cognitive biases that significantly influence their decisions.

Few people give investors a framework for navigating this disparity like William “Bill” Bernstein. It is why his books are on many people’s lists of recommended reading for investors.

Bernstein’s latest, the second edition of “The Four Pillars of Investing” (McGraw Hill, 2023), is likely to be added to such lists. In it, he strikes a balance between growing wealth and protecting against what he describes as the worst 2% of the time. In his article, you’ll see Bernstein discuss the importance of both not interrupting compounding and protecting against major downside risk. He bridges the math of investing with the human element—how we act in real time and our short-term need for liquidity.

Attempting to teach someone how to invest through downside volatility is akin to teaching them how to ride a bike. No amount of instruction can replicate how you will feel the moment you head at high speed into a turn that is sharper than you expected. (Trust me, I had that very experience during a criterium—a bicycle race held on a circuit road course. Fortunately, I did not crash and made it through the turn.) The same applies to a bad market environment. Many investors find that their resolve to maintain a high allocation to stocks isn’t as strong as they think it is.

For years, I’ve shown a slide when I do presentations that reads “The optimal allocation is the one you can stick with no matter what the market is doing.” Bernstein expresses a very similar line of thinking: “What I like to say is a ‘suboptimal portfolio’ that you can tolerate is better than an ‘optimal’ one that you can’t stick with.” Call it confirmation bias on my part if you want, but it is still darn good guidance.

Think about what happened last year. Traditional asset allocation strategies experienced losses as both stocks and bonds fell in value. Those who didn’t budge are now seeing their portfolios recover. It was a lesson in the importance of both taking a long-term view and having enough cash or cash equivalents on hand to cover shorter-term expenses and to take advantage of the bargains that appeared in the stock and bond markets.

How you reacted last year may have also been influenced by your personality traits. Hongjun Yan of DePaul University and his two co-authors looked into how each of the Big Five personality traits related to investing. The “Big Five” identify the differences between people’s personalities.

When it comes to investing, neuroticism had the biggest impact, while agreeableness—which one online test said is the trait I rank highest on—doesn’t have much of an impact. The study Yan and his co-authors did was based, in large part, on a survey of AAII members. (Yes, we show the personality traits your fellow members scored high and low on in the article.)

As a nonprofit organization, we are periodically contacted by professors seeking to conduct research on individual investors. We assist them by sending out surveys on their behalf. Participation is always voluntary, but the professors conducting such studies—including Yan—have told us how grateful they are to the AAII members who participate.

So, what’s the takeaway about personality traits and investing? Knowing what your personality inclines you to do can make you aware of the choices you are more likely to make. For example, those who score high on openness are more likely to invest in risky ventures. You can use the knowledge of your personality traits to set rules or take measures to protect yourself from your behavioral tendencies (by taking more risk if you score high on neuroticism or including some less risky, more traditional investments if you score high on openness, for example).

Before we go, I want to point out that we are reviving our Beginning Investor column in this issue. We are doing so in response to member requests for more content in this area. If there are certain topics you would like us to cover in future Beginning Investor columns, let us know by emailing journal@aaii.com.

Wishing you prosperity and good health,