When it comes to celebrity investors, they should be observed not followed.

More and more investors seem to look on the involvement of celebrity investors like Warren Buffett or Bill Gates as something of a pedigree for a stock. They reason that if Bill or Warren is involved, the stock must have some good qualities. So, they wonder, how far wrong can they go if they buy too?.

This attitude suits the times we live in. The economy has gained some momentum and the stock market outlook is positive. Investors take some encouragement from these events, but they are still eager for signs of confirmation. In today’s celebrity-obsessed world, it’s natural for them to place a premium on celebrity-investor endorsements.

Predictably, the newsletter industry has seized on implied celebrity endorsements as a marketing tool. Some publishers try to reduce a celebrity investor’s stock-picking approach to a repeatable collection of ratios. Others just apply labels like “Warren-Buffett Style buy” to their personal favourites.

You can expand your investment understanding by studying the investment choices of any successful investor, celebrities included. But you need to remember that all investors suffer from the same limitation: nobody gets it right every time. About a third of all your investment selections will inevitably disappoint you.

If you’re currently working with a broker you may also want to test to see how much of his or her recommendations come from the media. After all, brokers get information from the media, investment journalists spend a lot of time talking to brokers, and company managers listen to both. A feedback loop can develop that spurs high expectations, derails criticism, and leads companies (and their investors) to make devastating mistakes.

Needless to say, lots of smart people work in the public relations and brokerage businesses. That’s why it’s a mistake to stuff your portfolio full of stocks these people have publicized. A high corporate profile may provide investors with a feeling of security, but it doesn’t pay them any dividends. Instead, in-the-limelight stocks trade at a premium.

Here are some risks and limitations you face when you try to derive investment advice from the choices of celebrity investors:

1. Celebrity investors (Warren Buffett in particular) sometimes get offered investment opportunities on especially favourable terms that are unavailable to the rest of us. That’s because their involvement lends prestige and public relations value. They can make money even when ordinary investors lose.
2. Even though celebrity investors have access to better investment terms than the rest of us, they may still make huge investment mistakes. Many ordinary celebrities and celebrity investors got duped in virtually all the worst and most publicized investment frauds and disasters of our time—the Bre-X’s, Madoff’s, Tyco’s and so on.Celebrities generally conceal their best holdings until they are legally required to reveal them, except when they want to encourage buying by outsiders. They like to hold off on talking about their picks until they have finished buying (and driving the price up).
3. You might say some current celebrities (Paris Hilton is an example) are “famous for being famous”, rather than for personal achievements. Something like that also applies to investment celebrities. Bill Gates got to be an investment celebrity by founding Microsoft and hanging on to his Microsoft stock for decades, not because of his stock-picking record. On a more mundane level, many top investment people achieved success by working hard in university, then climbing the corporate ladder in an insurance or mutual-fund company.
4. Some newsletter publishers base their advice on patterns they claim to detect in the financial ratios of stocks that celebrity investors favour. But there’s more to investment success than using the right financial ratios. All top investors we’re aware of have also developed an enviable sense of investment judgment.

This sense of judgment falls far short of perfect, of course. But it goes a long way toward helping these investors spot great stocks and avoid disasters.

Do you have favourite celebrity investors that you follow? Have you taken their advice? Was it profitable? Share your experience with us in the comments.