There are few spectator sports more enthralling than American bull riding. The challenge of staying mounted on a bucking bull for at least eight seconds is a supreme test of courage, athleticism and skill. If you aren't familiar with it, just watch this footage from last year's Anaheim Open, just a short drive from IFA's Orange County headquarters, and you'll see what I mean.

Of course, most of us would never contemplate trying to stay on a bull for a single second, let alone eight. But what if you had no choice? Perish the thought, what if you had to ride a bull all day and every day for decades?

As Mark Hebner explains in Step 10 of his award-winning book Index Funds: The 12-Step Recovery Program for Active Investors, bull riding is an excellent analogy for equity investing.

"Envision the market as a wild bull, bucking up and down, rearing and spinning. Investors are like bull riders," writes Mark, "trying to hang on as the bull kicks and twists, making for a tumultuous ride. Matching the right portfolio to an individual's ability to handle risk is akin to finding the right bull that each investor can ride through all the ups and downs of the market."

Stock markets are like rollercoasters

Now you might be thinking Mark's bull riding analogy is a little dramatic, but, when we go for long periods without significant volatility, it's easy to forget  what a rollercoaster ride being invested in stocks can be.

In 2008, for example, a collapse in the U.S. housing market and the failure of major financial institutions led to a global market meltdown. The S&P 500 fell by approximately 38.5 percent that year. The VIX volatility index, which measures market risk and investor sentiment reached a peak of about 80 in November 2008, compared to its historical average of around 20.

In 2020, the onset of the COVID-19 pandemic again sent markets into a downward spiral. In March 2020, the S&P 500 saw its fastest drop into bear market territory on record — it took just 22 days for the market to fall by 20 percent. The VIX peaked at around 82, reflecting intense investor anxiety and uncertainty about the future of the global economy.

The best advice at times such as these is to sit tight. But of course, that's very much easier said than done. Human beings are emotional animals and we're prone to act on impulse. We also feel the pain of losses, and the fear of further losses, especially keenly. So, when markets fall sharply, the danger is that we lose control of our decision-making process and reduce our risk exposure or even flee the equity markets altogether.

Short-term comfort vs long-term pain

When investors capitulate like that, what they're seeking is short-term emotional comfort, and, in most cases, taking action provides them with the immediate relief they crave. The problem is that the long-term negative consequences can be very serious.

Why is that? Well, there are two main reasons. The first is that, by selling stocks after markets have already fallen, you're effectively turning paper losses into actual losses. The second reason is that you risk missing out on future market gains. In fact, the biggest stock market gains often come in the immediate aftermath of the steepest falls. Markets can and do rebound remarkably quickly.

2020 provided a spectacular example of a market rebound. To the surprise of almost everyone, stock prices started to recover almost straight away, largely in response to unprecedented levels of support for the economy and household finances from the U.S. Federal Reserve, the federal government, and from other central banks and governments around the world. By August 2020, just five months after the market plummeted, the S&P 500 had fully recouped its losses and had begun setting new record highs. Most investors who panicked in March didn't get back into the market in time and didn't benefit at all.

But what if markets take much longer to recover? Well, that's what happened after the crash in October 2008. The S&P 500 eventually reached its nadir in March 2009, and it wasn't until early 2013 that the index returned to its pre-crash high from October 2007. With the benefit of hindsight, March 2009 was an excellent time to invest. But that was when investor sentiment was at its lowest ebb and when only the very bravest investors were buying. Most investors missed the recovery, and in fact many were so traumatised by the crash and ensuing bear market that they stayed on the sidelines for several more years after that.

You are your own worst enemy

To put it simply, it's very easy to invest when markets are soaring and confidence is high, and very hard to do so when markets have fallen a long way and show little or sign of recovery. That's why most people typically buy when prices are high and sell when they're low — the very opposite of what they should be doing. As Benjamin Graham famously wrote in his best-selling book, The Intelligent Investor: "The investor's chief problem — and even his worst enemy — is likely to be himself."

Every year we're reminded of just how right Graham was by the publication by the investment research firm Dalbar Inc. of its annual Quantitative Analysis of Investor Behavior report, or QAIB. The charts below are based on data from the latest report and show the difference in performance as well as the growth of $100,000 between the average equity investor and the S&P 500 Index for the past 30 years (through 2023). Returns for the average investor were about 44 per cent lower than the index return.

To return to Mark Hebner's bull riding analogy, most investors find the bull they're sitting on just too hard to ride and eventually fall off. Many have fallen several times.

Identify your capacity for risk

So what's the answer? Well, it starts with identifying what we call your capacity for risk. That will be different for every one of us, which is why we give each of our clients a risk capacity score, ranging from one to one hundred. Your risk capacity score is a measure of how much risk you can personally manage as an investor.

We base the risk capacity score on five specific dimensions of risk capacity — your time horizon, your attitude towards risk, the investments you already have, the income you earn, and the level of your investment knowledge.

The aim is to take as much risk as you need to, can afford to, and as you feel comfortable with — but no more. Taking too much risk — or indeed too little — can land you in serious difficulties.

So, if you've never worked out your risk capacity before, why not do it now? All you need to do is click on this link and answer a few basic questions. Once you know what your personal score is, we can help you to build a portfolio that's just right for you.

Again, it's like finding the right bull for you to ride. The key is to find a bull that you can stay on and that won't throw you off.

Remember, we're all different. You might be able to take a level of risk that someone else considers far too high. Or you could be far more conservative and risk-averse; indeed, depending on your specific goals and circumstances, you may not actually need to take much risk at all. The chances are, you're somewhere in between.

But don't delay: discover your risk capacity score today. Whatever it is, we have just right the bull saddled up, suitably tamed, and waiting for you to ride.

 

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ROBIN POWELL is IFA's Creative Director. He always works as a freelance journalist and author, and as Editor of The Evidence-Based Investor.

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This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product or service. There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal.  For more information about Index Fund Advisors, Inc, please review our brochure at https://www.adviserinfo.sec.gov/ or visit www.ifa.com.