It may be that as you look at the previous section and clearly identify yourself as a greedy rather than as a realistic investor, your response is, “So what?” You may rationalize this investing behavior as crucial to your success. You are aggressive, confident, and willing to take risks; you made a significant amount of money in the market in the past, and you intend to do so in the future, and the only way you know how to do so is by thinking big and investing like a big-time player.

In fact, big-time investors are big-time precisely because they aren’t greedy. They are highly successful because they understand the way the market works, do their homework, analyze their options carefully, and then make decisions with both short-term and long-term results in mind. The greedy investor, on the other hand, gets into all sorts of financial trouble because his greed is based on an unrealistic view of the market.

For instance, greedy investors frequently fire their financial advisors for the worst reasons. The only thing that might be keeping their portfolios healthy is taking at least some good advice from investment advisors, and once they end these relationships, their portfolios suffer. Typically, the greedy investor will be at a cocktail party, work, or some other function and someone will be talking about how his money manager helped him secure a return of 20 percent in the year just ended. The greedy investor, who only had a 10 percent return, will immediately fire his advisor for only performing half as effectively as this other person’s money manager. While it may be true that this money manager did a great job this year, the question that is rarely asked is: “How did this person do the year before, and the year before that?” It may be that in the previous year, this money manager lost 20 percent while the market was only down 5 percent. The point is that you need to be thorough and analytical about all your investing decisions, and greed can cause you to act reflexively and emotionally.

FundsGreed also causes people to chase performance. They focus on finding the hot money manager or mutual fund, as if this discovery might be the magic they need to find their pot of gold. The problem with focusing on a person or investment who will make you rich is twofold: Not only do you ignore the investments and advice that will make you wealthy in the long-term, but you are blind to how this greedy investment strategy sets you up for a fall. For instance, greedy investors pile into energy stocks after they have appreciated 40 percent the previous year, failing to realize that the odds of this trend continuing are considerably reduced by the previous year’s unprecedented success. Or they dump their underperforming drug stocks when they are at decade-low prices, failing to assess whether there is a reasonable chance that they have hit bottom and will start a slow but steady climb from this point forward. Or they avoid stable, large-capitalization stocks that may only appreciate at 10 to 15 percent annually since in their mind, this is only average performance.

This desire for high performance makes them vulnerable to being burned. They place too much value on any tip that crosses their paths, regardless of the source. If their barber, best friend, or bartender gives them some “inside information” about a stock, they often take it as gospel because their greed makes them want it to be true. They may even artificially elevate a prospective investment in their own minds, convincing themselves that A plus B equals X; that a news report about a resurgence in the biotech market combined with a favorable university study about a new biotech product means they should invest heavily in a biotech company that just went public.

The third negative outcome of greed is a lack of due diligence. In their rush to strike it rich, investors make decisions based on scant research. When considering various options, they don’t compare the revenues, PE ratio, or measures for the peer group. They aren’t aware of cash flow needs of the relevant companies or earnings growth (or lack thereof) over a period of time. What they usually do know is a single, overwhelming fact that (in their minds) makes everything else superfluous. Here are some examples of overwhelming facts:

  1. A new “superstar” CEO has been named to head a company, and he enjoyed spectacular success at the previous company he headed, as described in a cover article in a major business publication.
  2. The stock price is rising rapidly on the basis of rumors about the company’s R&D breakthrough.
  3. A friend who has a brother-in-law who works for an organization told you that his brother-in-law’s company will be making an announcement next week that it is merging with its biggest competitor.
  4. You were watching the news and your favorite stock analyst enthusiastically and convincingly recommended a stock.
  5. You saw a list of the best performing mutual funds for last years, and the one at the top of the list has delivered an astonishing 32 percent.

These facts make greedy investors act before thinking. They are so concerned at missing out on a windfall, they buy before they have done the proper research. Though I’m not a psychologist, it seems reasonable to speculate that they don’t want to do the research because it might dash their dreams of riches—the fund that delivered 32 percent in the past year may have recorded a minus 35 percent in the previous year.

In addition, greed often prevents investors from monitoring their successful investments for numerical and other signs that it’s time to sell. Greedy investors always want more, and they have trouble admitting to themselves that a successful investment won’t keep being successful indefinitely. Even after tripling their money and having a stock that is selling at 100 times earnings, greedy investors won’t get rid of it; they won’t even be aware of the multiple at which it’s selling. They won’t take the time to look at the investment from a historical perspective and put its present performance in context. As a result, they invariably push a successful investment’s limit too far; they lack the data to identify when a stock price is at, near, or just past its apogee, and the only direction left is down. Even when it goes down, they don’t study all the data about the stock, the events taking place in the company, market trends, and so on. Instead, they may seize on one piece of positive news and use it to convince themselves that a stock will return to its former glory. Thus, they hold on to a loser far too long and suffer more losses than less greedy investors.

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Recognizing When Greed Is Causing Your Investing Problems