Broker Check

The Seven Deadly Investor Sins

February 16, 2024

The cold, hard truth of investing is that human emotions make us terrible investors. We can be irrational, moody, greedy, and fearful—all in one day, depending on what the market is doing. These actions can result in common investment mishaps like buying or selling at the exact wrong time. Most investors have a tough time separating emotion from their finances, which is why advisors must play the role of a coach every now and then. 

The excerpt below from DALBAR’s Quantitative Analysis of Investor Behavior does a great job of addressing the psychological complexities of investing: 

“When discussing investor behavior it is helpful to first understand the specific thoughts and actions that lead to poor decision-making. Investor behavior is not simply buying and selling at the wrong time, it is the psychological traps, triggers and misconceptions that cause investors to act irrationally. That irrationality leads to buying and selling at the wrong time, which leads to underperformance.  

There are 9 distinct behaviors that tend to plague investors based on their personal experiences and unique personalities.” 

These nine investor behaviors lead investors to fall prey to the seven deadly sins of investing, listed below: 

  1. Stock Picking - Envy: 

    Stock picking involves coveting specific stocks that appear lucrative because someone else recommends them. This desire to replicate others' success can prompt investors to make decisions based on comparison rather than thorough analysis. Whether it's a tip from a neighbor, a recommendation from a blog, or a mention on a TV show, succumbing to the envy of others' perceived gains may lead investors astray from their own investment strategies. Always remember that for every multi-bagger stock someone brags about, they likely have multiple flops to go along with it. 

  2. Market Timing - Greed: 

    Market timing stems from an insatiable desire for wealth and attempting to maximize gains by predicting short-term market movements, often fueled by a fear of missing out (FOMO). Market timing can involve getting out of the market attempting to time a market crash, or it could be taking a heavier allocation into equities to catch a bull run. Either way, most seasoned investors will tell you it's about time in the market not timing the market. 

  3. Overconfidence - Pride: 

    Past successes can lead to overconfidence, by assuming that what worked before will continue to bring success. In the casino, they call this the house money effect. After a few wins you might believe you have a special ability to pick winning stocks or time the market correctly, leading you to take on more risk you they can handle. Overconfidence can also lead investors to believe they can predict short-term market movements accurately. This belief may result in frequent buying and selling of investments, leading to higher transaction costs and tax inefficiencies. 

  4. Concentrated Stock - Gluttony: 

    By overindulging in one stock and allowing it to make up a significant portion of your portfolio, you are ignoring the benefits of diversification and exposing yourself to excessive risk. Many times, a stock becomes concentrated because it performs well, and would result in a taxable gain if the stock were to be sold. Incurring a tax bill is never fun, we get that, but sometimes it’s critical to realize gains to maintain proper diversification. There are other strategies worth considering here, such as covered calls, protective puts, donor advised funds, and charitable remainder trusts. 

  5. Portfolio Drift - Sloth: 

    Like sloth, or laziness, neglecting the maintenance of a well-balanced portfolio can have adverse effects. Allowing a portfolio to drift without rebalancing may result in suboptimal performance and incremental risk drift. For instance, consider a 60/40 portfolio that isn't rebalanced; over time, it could gradually shift to a 65/35 or 70/30 model as equities outperform, inadvertently increasing the risk of the strategy. 

  6. Strategy Abandonment - Wrath:

    Like wrath, reacting emotionally rather than thoughtfully can lead to detrimental financial consequences. When investors allow their emotions to dictate their actions, they may be inclined to abandon their investment strategies hastily. Investing is a long-term game and success cannot be measured on a short-term scale. The abandonment of a strategy is typically a knee-jerk reaction due to recency bias. Just as wrathful actions are often regretted later, abandoning a well-thought-out investment strategy can result in missed opportunities and potential losses. 

  7. Track Record Investing - Lust: 

    The desire for higher returns often draws people to what's made big gains before. This approach, often dubbed track record investing, means looking only at past performance without considering the bigger picture. But just because something did well before doesn't mean it will again. It's like chasing after something because it's been good in the past, without thinking about whether it will stay that way.  

By associating these investor sins with the traditional Seven Deadly Sins, it emphasizes the behavioral and emotional aspects that can lead to poor investment decisions. Understanding and mitigating these tendencies can contribute to a more disciplined and successful investment strategy. Conversely, the seven virtues of investing stand as a counterbalance to these sins: 

  1. Patience

    Waiting calmly for investments to grow and compound over time without succumbing to impulsive decisions. Good things take time. 

  2. Diligence: 

    Consistently putting in the effort to research and monitor investments to make informed decisions. Rebalance and maintain proper diversification.

  3. Temperance: 

    Exercising restraint and moderation in investment decisions, avoiding excessive risk-taking or speculative behavior. Avoid the FOMO of going all-in and avoid concentrated stock positions.

  4. Humility

    Acknowledging that investing involves uncertainties and being open to learning from both successes and failures. Odds are, if you don’t eat, sleep, and breathe personal finance, you are likely not a stock picking or market timing guru.

  5. Charity

    Recognizing the importance of giving back and supporting charitable causes with a portion of investment profits. Consider qualified charitable distributions for those who have reached age 70.5.

  6. Self-Control:

    Maintaining self-discipline in managing investments and resisting emotional impulses that may lead to irrational decisions. Establish a plan and stick to it, in both good times and in bad.

  7. Freedom

    Using wealth to empower oneself and others, promoting personal and societal growth. In retirement, you are no longer working for money, your money is working for you.

      For any investor, mastering self-discipline is paramount to steering clear of these sins and adhering to the virtues of investing. It's about staying focused, making sound decisions, and sticking to your long-term goals, even when the market gets turbulent. So, whether you're managing your investments on your own or with the help of a financial advisor, focusing on self-discipline can make all the difference in your financial journey.