The Worst Way to Invest

Ever envision yourself making a picture-perfect call similar to hedge fund manager John Paulson's bet against housing and mortgages in 2006?

If so, stop. Now.

Don't get me wrong -- there's plenty of money, bragging rights, and personal satisfaction that come with making a killer move like that. But it's important to remember that hedge fund managers like Paulson have very different motivations than we individual investors do.

Different how?
To start with, a lot -- if not most -- of the money that big hedge fund managers put on the line isn't their own. That's not to say that they're cavalier about how they invest it; far from it. But the billions of dollars that these investing rock stars are putting to work give them a shot at making huge scores for themselves if their big bets pay off.

In Paulson's case, that big score was an unbelievable $3.7 billion payday in 2007. Yeah, you read that right: $3.7 billion. While they may not be taking home paychecks quite that large, the situation is similar for the proprietary traders at Goldman Sachs (NYSE: GS  ) who risk company (read: shareholder) capital to try and make those huge scores.

Payouts aside, a well-publicized big win for a hedge fund manager can attract millions or even billions of new investor capital that will boost the manager's personal bank account in the future.

And we've seen in spades what can happen when these big bets go awry. Traders inside AIG's (NYSE: AIG  ) financial products division making big bets on derivatives nearly blew up the entire company. Misguided strategies that bet big on the mortgage market and derivatives ended Lehman Brothers and Bear Stearns. It's also hard to forget about the calamities at Amaranth Advisors and Long Term Capital Management. And the list goes on.

Big bets and your future
In your investment portfolio you don't get paid based on 2% of funds managed and 20% of gains. Nor do you benefit from the so-called "trader's option," where short-term gains can net big paydays (even if those bets cause massive losses down the road), while big losses mean they simply switch firms.

The majority of individual investors are investing for the long term, whether to buy a house, pay for a child's college education, or fund a comfortable retirement. A big bet that sours in your portfolio and causes catastrophic losses can take a heck of a long time to recover from -- if you recover at all.

Hedge fund traders and managers that fail, on the other hand, often find other opportunities open to them. Brian Hunter, a trader who's been credited with Amaranth's $9 billion collapse, became an advisor to one of Peak Ridge Capital's hedge funds after Amaranth sank into the abyss -- and is presumably back to making gobs of money for himself.

We can't expect the same kind of institutional largesse if we blow up our portfolios.

Better role models
We tend to talk a lot about Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) Warren Buffett and Fidelity Hall of Famer Peter Lynch. Some folks may even say that we focus on them too much. Me? I don't think we can focus on them enough.

Buffett and Lynch aren't well-known because they made a fantastic call right as the market was making a huge shift. They made their way into investment lore by practicing good investing fundamentals, investing for the long term, and chalking up lasting returns for their investors.

The lesser-known, but highly successful, Bruce Berkowitz, who runs Fairholme Fund, has produced awesome returns for his investors for over a decade. Rather than make outsized directional bets that could implode his fund, his equity strategy is focused on buying stocks like Pfizer and Leucadia (NYSE: LUK  ) when he believes they are undervalued and holding onto them for long stretches.

The advisors at Motley Fool Stock Advisor take a similar approach to investing in quality stocks at good prices that can be bought and held for the long term. A couple of the team's top recommendations right now are Western Union (NYSE: WU  ) and Atwood Oceanics (NYSE: ATW  ) . You can read all of our analysts’ research on these, plus their eight other “best buys now” with a free 30-day guest pass.

But if I can leave you with one thing, it's this: If you need to assert bragging rights, drive the lane in a pick-up basketball game or check-raise the nut flush in your weekly poker game. Leave the massive market bets to the hedge fund managers who will have millions (if not billions) in the bank even if they blow it.

Fool contributor Matt Koppenheffer owns shares of Berkshire Hathaway, but does not own shares of any of the other companies mentioned. Berkshire Hathaway is both a Motley Fool Stock Advisor and Motley Fool Inside Value selection. Western Union and Pfizer are also Inside Value picks. Leucadia is a Stock Advisor recommendation. Fairholme Fund is a Champion Funds selection. The Fool owns shares of Fairholme and Berkshire Hathaway. The Fool’s disclosure policy saw Matt get re-raised holding a low flush and watched him fold it like a little girl.