Search Jim Cramer's "Mad Money" trading recommendations using our exclusive "Mad Money" Stock Screener.This program last aired July 17, 2015.
Diversification is still the only way to invest, said Cramer, admitting he occasionally gets it wrong. Sometimes his stock picks just simply don't work out. That's investing. Any investor putting together an investing portfolio needs to be prepared, said Cramer, because sooner or later something won't work out.
But how should investors prepare for the next market catastrophe or stock pick gone bad? Not by being bearish but by being smart, Cramer said. Being a bear means shorting stocks, hoping they go down. That's a valid investing strategy but it limits one's profit potential since the lowest a stock can go is zero.
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However, Cramer said, compare that to bullish investing, betting that stocks go higher. Their potential profits are limitless, he said. Investors who invested in Action Alerts PLUS holding Apple (AAPL) in 2009, for example, realized a 580% gain over the next three years.
Beyond having a positive outlook, Cramer said the most important rule to managing your money is diversification. That means not having all your eggs in one sector basket. A portfolio with five stocks must have only one technology company, one health care name, one energy company, one industrial, etc. Two or three of a kind is a quick way to get caught off guard, so no more than 20% of a portfolio can be in a single sector.
Being diversified is more than just investing in different sectors, however. Cramer said the new rules of diversification also require owning some gold in your portfolio along with a high-yielding dividend stock, a growth stock, a speculative stock and one that's firmly rooted in a healthy geography.
Check the Dividends
Cramer said the most important category of stocks that must be in a diversified portfolio is a high-yielding dividend stock. He said that every portfolio needs at least one, possibly more, dividend payers.
While dividend stocks might not seem sexy, dividends make money. In fact, nearly 40% of the total gains from the S&P 500 since 1926 have come in the form of dividends. Over the past decade, that percentage is even higher, he said.
Dividends aren't merely safety plays for retirees and cautious investors, said Cramer. They are a smart strategy for making money. He explained that as a stock price falls, its dividend yield increases, which, in turn, makes it more attractive to investors. Stocks that hit a 4% yield represent terrific long-term bargains, he noted, which is why stocks typically stop going down once they hit 4%.
But beyond making money, Cramer said dividends -- and especially dividend raises -- are management's way of telling investors that things are going well at a company. A solid, steady dividend that gets raised regularly is a hallmark of a company that's stable and doing well.
Not all dividends are created equal, however, cautioned Cramer. He said dividend yields that are not sustainable are red flags. Just look at what happened to Radio Shack (RSHCQ) and supermarket SuperValu (SVU) in early 2012 for a lesson in dividends gone awry. Cramer said a company's earnings per share should be at least twice that of its dividend payout to be considered safe. For companies with high capital needs, like telcos, he said investors can look at the cash flow as another metric to see whether the dividend may be in jeopardy.