The Costly Habit Warren Buffett’s Mentor Warned Against, and How You Can Fix It Today

A crucial lesson from Benjamin Graham—the legendary investor who was a dear mentor to Warren Buffett—involves how different investing is from the other things we do: The very trait that drives success in most areas of life can wreck your financial future.

“While enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster,” Graham warned in his classic book, “Security Analysis: Principles and Technique.” This counterintuitive insight from the man who shaped Buffett’s investment philosophy explains why even brilliant investors often fall prey to market bubbles and emotional decision-making.

Curbing Your Enthusiasm

In his “The Intelligent Investor,” Graham wrote that Wall Street transforms enthusiasm into a liability even though it fosters success in other fields.

Market enthusiasm, he argues, functions like “an artificial stimulant” that makes investments seem more attractive, as outsized valuations might be validated by other investors and the fear of missing out (FOMO). When investors see others profiting from trending investments, rational analysis is often pushed aside by fear, greed, and, yes, enthusiasm.

This psychological vulnerability affects nearly everyone. As markets rise, enthusiasm creates a self-reinforcing cycle: price increases supposedly confirm existing enthusiasm, drawing more participants, further driving prices upward as herding behavior takes hold—until the inevitable collapse.

Research in behavioral finance shows that during these periods, investors systematically overestimate their ability to sell off without losing too much while underestimating their risks.

Graham noted that even brilliant minds—he references Isaac Newton, who lost a fortune in the South Sea Bubble—can fall prey to irrational exuberance.

Fairy Tales and Failing Scales

Central to Graham’s work was his claim that enthusiasm causes investors to lose sight of what’s most important to him and Buffett: the actual value of a stock. As the bulls run on the stock market, conversations shift from fundamentals. Price-to-earnings ratios may soar, say, from 15 to 50 or more, as overenthusiastic investors justify these valuations with tales about exponential growth or revolutionary business models.

When pressed on valuations, enthusiastic investors often respond with some version of “this time is different” or “traditional metrics don’t apply here.” Investors stop being analysts and become trend followers, often with disastrous consequences when fundamentals do reassert themselves.

Echoing Graham, Buffett once told Berkshire Hathaway Inc.’s (BRK.A) shareholders about the perils of moments: “The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money.”

Defense Mechanisms

Here are some safeguards that can help during market run-ups:

• Put in some guardrails: Set specific objective criteria for buying and selling that must be followed, no matter how the market or investor sentiment shifts. This might include maximum valuation thresholds based on financial models or automatic profit-taking rules.
• Record your trades: This goes beyond just listing your trades—your brokerage will have that anyway—to recording why you made them.
• Cultivate skepticism and contrarian thinking. While not every trendy investment is bad, ready yourself to be especially cautious when ideas become hot topics at social gatherings or dominate social media. As Buffett often repeats, “Be fearful when others are greedy, and greedy when others are fearful.”

“The market is not a weighing machine” where price tells you exactly the value of something, Graham wrote. “Rather, should we say that the market is a voting machine,” reflecting a mix of reason and emotion. Indeed, few saw the dot-com or housing bubbles bursting—until they did.

For both Buffett and Graham, what’s central to successful investing isn’t a superior intelligence but the ability to resist the enthusiasm that’s so often destructive of portfolios.