The good news about this investing sin is that you have a number of ways to reduce its negative impact. Here are some steps you can take to reduce your gluttony and find a more healthy balance between active trading and watchful waiting:

A. Reserve 5 to 10 percent of your portfolio for aggressive trading.

Just as a diet isn’t designed to eliminate all food—or even all junky food—a good regimen for the investing glutton isn’t to cut trading entirely. For whatever reason, you enjoy and need the action of buying and selling. What you don’t need is for this need to eat away at your portfolio. Therefore, reserve a small percentage to feed this habit. If you only actively trade 100 shares instead of 1,000, you probably won’t do much damage.

Remember, though, that this 10 percent high-end percentage is absolute! Invariably, a time will come when the actively traded 10 percent will be performing well, and the inner glutton’s voice will say, “Don’t be a sucker; you’re a much better investor now than before; up the percentage to 20 percent?’ Do not heed this voice. It is the same voice the dieter hears after losing ten pounds, the voice that says, “Another slice of chocolate cake won’t hurt you?

B. Limit your active trading to an IRA or some other tax-deferred account.

This can include a company 401(k) if allowed or an IRA rollover from a previous employer; the rollover can often be transferred to a discount brokerage account from the custodian of your former employer. Obviously, limiting your active trading to tax-deferred accounts will help you avoid paying big short-term capital gains taxes.

C. Refuse to invest in the stocks and funds that everyone is talking about.

I recognize that this is going to be difficult advice to follow. For a glutton, especially, it will feel counterintuitive. You hear the “buy” recommendations, notice a strong earnings report, read stories lauding a company’s future, and your impulse is to strike while the iron is hot. As we’ve indicated, however, the iron is already starting to cool when you makeyour buying decision. The stock that is rated a “buy” by 20 out of 21 brokerage firms has great expectations already built into its price; the majority of people have already discovered and bought it, and the odds are against a significant number of additional people flocking to the stock and helping further inflate its price.

FundsGluttons who want to keep their vow not to chase performance should keep eBay in mind. Since going public in 1998 until the end of 2004, eBay’s stock price rose thirty fold from its IPO. In a very average year for equities in 2004, eBay rose 80 percent. The P/E ratio was over fifty times 2005 earnings estimates. Despite all this, buying eBay at the start of 2005 would have been a mistake. Even though it has consistently received “buy” ratings and exceeded earnings estimates, it was tapped out from an investing standpoint. After missing the earning estimate by 2 cents for the first quarter of 2004, eBay gave back nearly the entire appreciation in price of 2004 in the first six months of 2005.

To stop chasing performance, here are some warning signs to heed: — The majority of brokerage firms have issued “buy” recommendations.

  1. A big story appears in a major business publication lauding a company’s performance and future prospects
  2. A stock or fund’s price has consistently been going up for more than a year
  3. The high performance of a stock has you saying to yourself, “I wish I would have bought that years ago.”
  4. More than one friend or colleague tells you about the stock or fund they invested in, its great performance and how you should get in on the action.

D. Substitute buying “beaten up” stocks for high-performing ones.

To satisfy your craving for action, look toward solid stocks that have taken a beating. In other words, find a company that has a stellar reputation, a history of good performance, and other outstanding attributes, but for one reason or another has experienced problems that have depressed the stock price. Obviously, you don’t want to choose Enron-like companies that have committed fatal or near-fatal blunders, but ones that have been hurt by forces beyond their control. Every organization runs into bad luck now and then; every company fails to seize an opportunity or commits an anomalous mistake. If you can find the window when the price has fallen lower than it should be—when the market has overreacted to negative events involving the company—then this is the moment when your impulse for action can serve you well.

Ideally, you want to find a stock like Merck & Co. After the company announced the withdrawal of Vioxx on September 30, 2004, the stock fell from $45 to $33 per share in one day. It fell another $7 to $25.60 over the following six weeks due to litigation concerns. When the stock went below $30, many brokerage firms changed their rating from “buy” to “sell.”

In November, when Merck was at its nadir, the stock yielded almost 6 percent. The P/E ratio was at 10, and relatively few people were interested in purchasing the stock. The stock was off 45 percent from its 52-week high at this time, making it a wise buy for savvy investors. Merck met the qualifications I described earlier—it was a strong company with a great tradition and history of highly profitable products. Merck could not be blamed for the research revealing the dangers of taking Vioxx. It was an anomaly and not indicative of the effort they made to create safe, useful pharmaceuticals. This is not to say that significant litigation issues are not a concern for the stock in the future, but they seem to be largely priced into the stock. Apparently the market recognized this fact, since by 2006 Merck had recovered to $35 per share.

Gluttons like action and movement; they like the sense of being a player and finding hot stocks. By investing in companies like Merck that have taken a hit, they can satisfy these needs without taking the sametypes of risks as they would on a high-flyer. Certain investing gluttons have to be careful and not back a stock that is down and is never going to recover. They also must recognize that buying a stock like Merck is tricky, since no one is quite sure how deep the bottom is, and they may have to weather further downward movements in price before it goes up. Still, I’ve found that looking for beat-up stocks is a far better strategy for gluttons than looking for high-performing ones.

E. Increase benchmarking.

Every investing glutton should make a practice of comparing their portfolio’s performance with various market benchmarks, such as the S&P 500, NASDAQ Composite, or the Russell 2000. Doing this comparison once a month is a reality check of sorts. Too many gluttons view their investing performance through rose-colored glasses, and therefore feel no motivation to change how they invest. I would bet that the vast majority of gluttons perform below the market benchmarks. If this is the case, this monthly measurement will serve as motivation to change their overactive strategy.

F. Reduce the number of trades gradually.

Don’t immediately try and go from five investments a day to one a week. You’ll find this radical transition tough to maintain. Instead, diminish your trades incrementally. Go from five trades a day to one or two a day. Then in a few weeks, reduce this number to three or four trades weekly. If you find this rate tolerable, try and moving down to one trade a week. You don’t have to be rigid in this discipline—if two great investment opportunities arise in a given week, you should capitalize on them. You should, however, keep track of the number of trades you make and your ability to reduce their number and maintain that reduced number over time.

G. Use a passive or index strategy when investing in small caps.

I am tempted to recommend that investing gluttons avoid small caps altogether, since they can eat up an overactive investor’s money with great speed. At the same time, I recognize that gluttons are drawn to small caps and that they can offer a better return than large company stocks, especially when they are held for a significant period of time. According to Ibbotson Associates, over the 79-year period between 1925 and 2004, small company stocks have outperformed large ones by 2.3 percent per year.

If, however, you are tempted to be an active investor in small caps, recognize that this superior performance probably won’t apply to you.

Because there are thousands of stocks in this sector, you need to be extraordinarily knowledgeable and vigilant about which ones you pick. Even the average stockbroker is ill-prepared to handle small caps effectively. It takes a fund manager who does little else but small caps to navigate all the minefields in this area.

A passive or index strategy provides a much better alternative. You can purchase an exchange-traded fund such as the Russell 2000 iShares, which trade under the ticker IWM. This holds a basket of the smaller 2000 of the Russell 3000 index. The fund carries a modest expense ratio of only .20 percent annually. During a period of poor returns for the average equity investor, this fund produced an average annual return of 7.25 percent during its first five years of trading (from 2000 to 2005).

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