At 2:37 AM, Sadie went ballistic. Middle of the night. Barking like mad. Sprinting around the house.
I startled from serene sleep to heart-racing confusion, then lept out of bed and hurried to the living room. Fire?! Intruder?! What was happening?!
I still don’t know, but I have a guess.
We have a neighborhood fox. Sadie freaked out the last time she saw him. I think he returned. Thanks for defending us, Sadie…(kinda). Things calmed down after a minute, and we went back to bed.
But as I laid back down to sleep, I paused. My brain function, I realized, was far from normal. I didn’t recognize myself.
The previous minute was a fog of sleep deprivation and adrenaline. A “fight or flight” instinct had kicked in. I couldn’t explain my thoughts or actions. It was all reaction and instinct.
I want to reiterate and emphasize this: environmental factors fundamentally changed my internal thoughts.
My brain slowly shifted back to normal. And I pondered: “what if I had to make an important decision right now?”
Ask the Experts
The following comes from “Emotion and Decision Making,” a paper from Lerner (Harvard), Li (UC Riverside), Valdesolo (Claremont McKenna), and Kassam (Carnegie Mellon).
Researchers have found that incidental emotions pervasively carry over from one situation to the next, affecting decisions that should, from a normative perspective, be unrelated to that emotion.
An incidental emotion in my story is the frenzy caused by the fox. Imagine if I had immediately logged into my Fidelity account afterward. Would I have made a rational investing choice?
As the researchers point out:
For example, incidental anger triggered in one situation automatically elicits a motive to blame individuals in other situations even though the targets of such anger have nothing to do with the source of the anger
Fear from one situation can percolate into an unrelated situation. The same goes for excitement. We have one brain that handles millions of situations. Emotions from one situation pervade the brain, and other situations are affected. Logged into Fidelity, I might have sold all my index funds and bought gold! Oh nooooo!
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This doesn’t just affect individual writers with barking dogs. We can track emotional choices across huge swaths of populations. Sunshine should not affect stock prices. Neither should soccer results. And yet…
…based on the assumption that people are happier on sunny days, economists found a positive correlation between the amount of sunshine on a given day and stock market performance across 26 countries (Hirshleifer & Shumway 2003, Kamstra et al 2003). In contrast, stock market returns declined when a country’s soccer team was eliminated from the World Cup (Edmans et al 2007).
The evidence is clear. Emotions affect your decisions. Unless…
What’s the point of fire drills?
A building is on fire. A fire alarm goes off. I walk outside the building. Shouldn’t that be common sense? Why practice that activity—over and over and over—with a fire drill? Why waste that time?
I know why. And so do you, even if you’re not aware of it. It’s because of the “frenzy of the fox.”
We want people—especially kids—to have zero doubts about their reactions to a fire alarm. Zero doubts! Fire alarms are loud and scary. Emotions can run high. But there’s no time for panic, confusion, wrong turns, or pausing to grab Teddy the Bear.
We practice fire drills to eliminate that in-the-moment fear, uncertainty, or doubt. And to remind people, “Material items can be replaced.” And to imprint in our brains, “This is the fastest route to safety.” We practice fire drills to program our brains. Because in-the-moment emotions can kill us.
The confusion I felt with Sadie’s barking was acceptable for that scenario. We cannot afford the same confusion if the building is on fire.
The Fire Drill of Investing
What would you do if the stock market started burning down? This question is a fire drill, but for your investments.
I’ve asked this question to myself hundreds of times. I’ve read countless “the market is burning” stories before—of bear markets, panics, and crashes. I know the right “escape route.” When the market crashes, don’t panic and don’t sell.
Read more: The Market Crash Is Coming (…Eventually)
Why not? Why shouldn’t you panic? Because the market has crashed before and will crash again. A market crash is natural. Unlike a house fire, a market crash is expected, potentially healthy, and always recoverable. Over long periods of time—regardless of market downturns—positive performance has been close to a guarantee.
Selling during a market crash equates to selling low. And then you’ll be too nervous to buy back in as the market recovers. You won’t be invested as the market goes up. It’s a double-whammy of investing failure.
There are many instances of this story—of what not to do. Reading these stories acts as a stock market fire drill. I repeat these stories here to act as your fire drill. I hope it’s working!
And because I’ve practiced this “market fire drill,” I knew what to do in March 2020. Rather, I knew what not to do. I wasn’t panicked. I didn’t sell. I watched with curiosity. The drills had prepared me. In fact, I marched forward with my steady investment strategy and had faith that, eventually, the markets would recover.
No frenzy. No emotion. The fire drills had trained me. I was safe.
Sure enough, the stock market has doubled in value in just 16 months since the COVID-19 low.
We have eons of evolutionary wiring that command us to react to troublesome stimuli. Our instincts shout: Don’t just stand there—do something! We want to address our fears, and we project those fears through our decisions.
But it was index fund godfather John Bogle who famously said:
While the interests of the business are served by the aphorism ‘Don’t just stand there. Do something!’ the interests of investors are served by an approach that is its diametrical opposite: ‘Don’t do something. Just stand there!'”John Bogle
Ask yourself now: what will you do if the stock market crashes?
Or perhaps you’re not invested in stocks. There are other fire drills you can run:
- What will you do if a friend suggests you buy the $100 blouse?
- What will you do if your neighbor buys a brand new Tesla?
- What will you do if your cousin starts selling a pyramid scheme product?
Start wiring your brain pathways right now. Don’t let emotion incidentally affect you when it matters most.