Warren Buffett once said “Investing is simple but not easy”.

If you have invested in the stock market at some point, chances are that you have experienced a bear market, which is essentially a period when your investments keep losing value.

By definition, stock market investments come with a set of risks. One of the biggest risks is volatility i.e. the prices go up and down in an uncertain way based on external conditions. This is essentially how the stock market is designed to work based on the supply and demand.

That said, we humans are wired to panic during these market fluctuations (say a change of -10% or more). Historically, stock market investments have given positive returns in the long-run. If you have invested in basic equity investments like index funds and mutual funds, chances are that you’ll do well off with them in the long run of say, 10 years or more. However, it’s very hard to endure these 10 years of fluctuations, unless you are an ‘invest and forget’ sort of person.

Why do we panic during a market crash or correction?

Firstly, it’s your hard-earned money and seeing it lose value in front of your eyes is painful. In reality, you do not gain or lose value until you ‘sell’ it.

An event like a stock market crash essentially triggers your fight or flight response. Why? Because this is perceived by our brains as a ‘dangerous’ situation. While we have evolved in character and over the past centuries we have built amazing things like artificial intelligence, our brains still run on the old firmware, roughly 200,000 years old. Blame evolution, for our brains not catching up quickly.

We are wired to avoid losses

When humans were primitive creatures, it was important for our survival to avoid losses rather than look for gain. If you were living tens of thousands of years ago, and you come across a tree full of apples, but also a mammoth in front of it; your best choice would be to avoid the apple tree and stay hungry away from the scene. This is why we are still alive as a species. Had our forefathers just risked their lives all the time to get to their food, our species would have been wiped out by the wild animals.

Fast forward to today, our environment has significantly improved, but our poor brains still run on the old instincts and perceive stock market crashes as a threat situation, leading us to make irrational decisions.

We are wired to think short-term

While we are looking forward to a happy life in future, we are not designed to think rationally about our future self. Psychologist Hal Hershfield studied the brains of a set of people thinking about their future self and found something astonishing. (The Stranger Within) While thinking about the future selves 10 years ahead, the neural patterns activated the same region of the brain as that of thinking about a complete stranger. What does that say? We are not experts at thinking about ourselves in the future. With that sort of a ‘software’ running in our head, it would be reasonable to agree that we are not good at thinking into the future. But this is one of the fundamental requirements for long-term investing, i.e. to think long term.

What should we ideally do?

The ideal thing to do is to not panic, and be strategic. While I want to cover some traditional and practical advice before jumping into how to make use of AI here, if you want to know about that first, you can skip this section to the next section on AI below.

Preplan your investment decisions for a market crash beforehand

A market crash is not the best time to make investment decisions. Define your rules of engagement for a market crash well in advance, when everything’s going very well. Ideally it helps to have a document describing your investment philosophy and what you would do in situations like this. When everything’s going well, ask yourself “What should I do if the markets crash tomorrow morning.”

Use a rule-based investment framework

This was one of the ideas I learned from the book The Behavioral Investor by Daniel Crosby. Essentially, you invest based on certain simple if-then rules. For example - “If the markets crash a 10%, I will invest an additional 5% of my savings”.

Your portfolio allocation is key

This is an extension to the above point. If you decide in advance that you want to have a moderately risk-adjusted 60-40 portfolio (where 60% of your investments goes to equity and 40% in non-equity), you won’t have to do anything else other than adjusting to this ratio. During a market crash, your equity portion will come down, and you can balance it from the non-equity portion to meet the target, and do the opposite when your equities are doing extremely well.

How can AI help in this situation?

While most of the above may be traditional advice, you can leverage AI to stay informed and grounded in difficult market situations. While a pre-defined strategy works well for market downturns, it is also important to understand the current context. What is happening around you in terms of geopolitically or macro economically, can help you stay grounded. Here are some ideas that I often use:

Use AI to understand the current macroeconomic situation

While most of the downturns in equity markets get healed in a couple of months, it helps to understand what is happening around us. Nobody can accurately articulate why the markets are going in a specific direction, however, we can understand what are the factors guiding it. Use AI to understand the current geopolitical landscape that is shaping the market events. Here’s an example prompt:

“Can you give me an overview of the current macroeconomic situation and the recent events, both globally and locally, that are impacting the stock markets? Wrap it up with a short summary at the end.”

Use AI to assess your finances during a market crash

The prompt above will give you an idea about what is happening in the world, but it wouldn’t explicitly tell you what to do. Though we already have some of the traditional advice explained in the previous section, we can still use AI to double down on it. Firstly, we have to make sure that we provide enough context to AI to refine the recommendations. For this, we need to provide context about our investing persona. While it would make sense to have a separate post covering what should be included in your investing persona, as a simple example, your investing persona would ideally contain details like:

  • Your current age
  • Investing goals
  • Current equity allocation
  • Current income
  • Assets
  • Other parameters

You could use this context in the above prompt to make it more impactful:

“Considering my investing persona with the following details ((Add your investing persona details that we discussed above)) Can you give me an overview of the current macroeconomic situation and the recent events, both globally and locally, that are impacting the stock markets? Also assess as a personal financial advisor if I need to review anything in my portfolio given the ongoing macroeconomic and microeconomic situation and my investing persona”

Further Reading

  • The Behavioral Investor — Daniel Crosby
  • Future Self Continuity research by Hal Hershfield — The Stranger Within