Here the problem is lusting after a given investment even before it has proven its worth. For many reasons, people get it in their heads that a stock or fund is going to take off, and they buy too much too quickly. It is like falling in love at first sight. Suddenly, they have a singular focus and ignore everyone and every thing besides this one object of lust.

For instance, you subscribe to an investment newsletter, and you swear by it. In recent months, it has been right on the money with its recommendations, and it seems as if the newsletter author has the inside track on the market. Perhaps you recall George Gilder and hi Gilder Technology Report. People made a great deal of money in the late 1990s investing in the tech companies Gilder recommended. In fact, hi; picks were like self-fulfilling prophecies: If George picked it, the stock would invariably rise. Of course, by late 2000 just about all the tech stocks went down and people who took Gilder’s recommendations as gospel lost a lot of money.

FundsBecause Gilder was golden, lustful investors simply responded to his picks rather than doing their own due diligence. It is always a mistake to remove yourself entirely from the investment process. Whether you’re relying on a newsletter or a stockbroker, you need to remain informed and involved. Unfortunately, lust seems to make that information and involvement irrelevant. When you have a worshipful faith in an individual or an investment, you lack the motivation to do your homework. As a result, you buy without adequate analysis and then end up holding on to an investment without adequate monitoring.

This leap-before-you-look syndrome can also involve a mutual fund. People have a tendency to lust after single-sector funds. If you had bought a biotech fund at the beginning of 2001, you would have suffered greatly. Over the next four years the average biotech fund dropped over 30 percent in value. During this same period, the S&P 500 dropped less than 2 percent.

Similarly, people become obsessed with hedge funds because they help them win while everyone else seems to be losing. Some investors confer an exalted status on these funds and invest in them based only on the fact that they returned 15 percent in the previous year, unaware that they plunged 25 percent two years before. It is astonishing that many hedge fund investors don’t realize that these funds are loosely regulated partnerships that may invest in illiquid or nonmarketable securities. They can be extremely volatile and carry a high degree of risk. They are appropriate investments for a small part of your portfolio, but should never become your primary investment vehicle. Every few months there is an article about some hedge fund closing its doors and returning nothing to its investors. While such an event is very rare, inevitably there are investors who put all their net worth in one of these funds. In most cases when nothing is returned there is fraud involved. Anyone who has studied hedge funds over time recognizes that if retirement is your primary goal, it is a mistake to put a significant percentage of your portfolio in them.

To avoid this type of lust, do the following:

  1. Tell yourself that gurus and their newsletters are fallible, and that it’s fine to listen to their advice but you still must be responsible for research and analysis. Don’t worship gurus. Instead, respect them but vet their picks through your own evaluation process.
  2. Count to ten before you buy. Not ten seconds, but ten days or even ten weeks. Give yourself enough time to observe how a given stock or fund performs and get a sense of why it performs the way it does. Obviously, you don’t want to wait too long and miss out on a good deal, but it is much wiser to invest with your head than your heart. The former takes longer—any analysis of data is a relatively lengthy process—but it protects you from your own impulsiveness.
  3. Be cautious around single-sector funds, especially those that have enjoyed significant success over a period of months or years. As attractive as their returns might be, you are likely too late to the game, and at best you’ll catch the tail end of the cycle before you start losing big-time.
  4. Do not invest more than 5 percent of your net worth in a single volatile, speculative fund.

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Becoming Infatuated with an Investment’s Surface Looks and Buying Too Soon