The Seven Deadly Sins of Investing

It has been nearly five years since the depths of the U.S. financial crisis, and investors have learned a lot since then. Or have they?

Despite the downturn that left many investors reeling from losses on everything from real estate to the stock market, when it comes to investor behavior—those hard-wired instincts that drive us all—little has changed, say psychologists and financial advisers.

Investors still make the kinds of mistakes that have gotten them in trouble for decades. They are wooed by the hottest new trend, they want to follow the crowd—consequences be damned—and they just can't seem to pay enough attention to important details, such as the steep annual fees charged by many mutual funds.

"When it comes to money, we are operating as if we were in the jungle, having to deal with predators like tigers," says Brad Klontz, a clinical psychologist and associate professor of financial planning at Kansas State University. "We have a caveman brain."

Investing Sins

Dave Whamond

There are ways to avoid these pitfalls. Investors need a hard and fast plan of their investment goals, they need to find a trusted adviser or family member to help weed through decisions and they need to stop paying so much attention to the short-term events that drive media coverage.

Here are the seven deadly sins of investing, in no particular order, and how to protect against them.

Lust: Chasing Recent Performance

The belief investors feel that recent performance will dictate future performance—known as "recency bias" in psychology—is one of the biggest investor pitfalls, experts say.

"People tend to buy something that has done really well recently," says Terrance Odean, a professor of finance at the Haas School of Business at the University of California, Berkeley. "They chase performance."

In the lead-up to the financial crisis, investors dived headlong into real-estate investments, convinced that rising housing prices would never falter.

Gold prices peaked in 2011 and are now trading about 26% below their record high. Bloomberg News

The latest example: gold. The commodity went on a winning streak even before the financial crisis, and investors piled in.

A big factor was the heavy prominence gold suddenly received across the media—on commercials, in financial publications, on television shows and in books. Mark Berg, president of Timothy Financial Counsel, a fee-only financial advisory firm in Wheaton, Ill., says one otherwise rational client wanted to move her entire portfolio into gold after reading a book warning of another market crash.

To combat this behavior, financial advisers say it is important that investors study historical prices and performance of the latest popular investments. Historical charts, for example, will show the rise and fall of any investment over time.

Instead of looking just at prices over the past few months or a couple of years, look at the long-term history over periods extending back at least 10 years—and sometimes more. Gold, for example, had been increasing in price since 2001, but over the longer term has trailed stocks and barely kept pace with inflation.