Cramer's 'Mad Money': When to Speculate

Updated from 6:53 p.m. EDT

Speculation is something that can keep investors interested and enthusiastic about their money, and it can even be necessary under the right circumstances, Jim Cramer said on CNBC's "Mad Money" Wednesday.

Cramer said investors can't really call themselves diversified unless some of their money is in high-risk/high-reward situations.

"I've got a long track record, and almost all of my biggest wins have come from pure speculation," he said. "You must learn how to do it right. You've got to know the rules before I give you permission to use the tools."

He cautioned against using IRAs or other essential savings for speculating. Investors should have two portfolios, he said, one for retirement and the other with extra, discretionary money.

For example, he explained that he bought a basket of telecom stocks in 2002 including Lucent (LU Quote - Cramer on LU - Stock Picks), Nortel (NT Quote - Cramer on NT - Stock Picks) and JDS Uniphase (JDSU Quote - Cramer on JDSU - Stock Picks). The result was that the group brought in gains of more than 42% in less than a year.

Of the portfolio outside retirement savings or other long-term plans, Cramer said he would be willing to place up to 20% of the extra money into speculation. But for those who have less than $10,000, the best option would be to put the money in a diversified mutual fund portfolio.

Cramer said he likes to look at younger companies, rather than just those that have been beaten down, when speculating. "What I like to do is find the new ideas," he said. "We do not want to speculate on companies with bad balance sheets. You can speculate in the young companies and the ones with good balance sheets."

Investors could do all of their speculation in one stock or pool their funds into a group of stocks in a beaten-up sector. "Luck should not be part of the equation," he said, and he recommended against using margin for speculation.

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