Cramer on How to Start Your Own Hedge Fund

How do you start your own fund? I get asked that question at least three times a day. I always say the same thing: You start it by making money for yourself.

It's so many peoples' dreams to run money these days that I've got to tell you how I got started in this business. For me, I was always a stock picker. I had my own stock game in fifth grade, where I tried to beat the averages. I started a stock newsletter in 1978 that I would send only to my Mom and Dad. They followed it religiously and made a few bucks to boot.

In 1982, while I was at Harvard Law, I was recommending stocks on my answering machine, something that the securities law professors at Harvard told me violated the 1940 Investment Advisers Act, so I signed up to be one immediately. Boy, that process is barely a barrier to entry, let me tell you.

When I got to Goldman Sachs in 1984, I realized very fast that my chief strength, stock picking, didn't really play a role in my development as a broker. What mattered was finding new clients (cold calling) and getting to know the recommended list. No matter that I felt I was a better stock picker than almost anybody in the research department -- the two exceptions are now highly successful fund managers themselves -- I did not even get any time to study the market. My time was spent developing my client list, as it should be if you want to be a successful broker.

After four years, it occurred to me that what brought me into the business was the learning and picking of stocks, not the cold-calling, no matter how adept I got at it. The whole time I was developing my book, I was trading stocks for myself and making a ton of money. Sure the tape was great, but when hasn't it been in the last 15 years?

Which brings us to lesson one: I had a track record. It wasn't from my clients; heck we did not even have discretion over our clients' accounts. It was in my personal account, where I had racked up some impressive gains. That record belonged to me. I can't tell you how many young people I see who want to run a fund and when I ask them to produce a track record tell me: Why that is impossible, they have no record. That's nonsense. If you can only buy or short 100 shares, well then do it.

Don't have a dime? Then show me a paper portfolio and how it would have done. Don't have time to do that? Forget it, stay in the goshdarn sell side then.

To go off on your own you need to believe in yourself to the point where you would rather follow your judgment than anyone else's on earth. That's not easy given that earthlings include Buffett, Lynch, Heebner and Stansky. But if you don't believe that, please don't quit your day job.

But, equally important, you must budget for being able to live a year and a half without being paid. If you make no money the first year -- we are all paid big at year-end -- you have to have the staying power to at least get through half of the next year.

When I started I didn't get paid in year one, and literally had to borrow up to the max in my credit cards in the following year to make it to the end of year two. But I did.

Finally, you have to be able to weather more than one kind of cycle or move. When I left, after four years at Goldman, all I knew was the drug and food stocks. But a vicious rotation began not long after I was on my own. Investors rotated into the steels, aluminums, coppers, papers and plastics. I was clueless and had to have a crash course in those groups, one that put me way behind the hedge fund curve. Be sure your skill set include more than one group of stocks and more than one set of GDP variables.

If you have these all checked off you are ready. Now all you have to do is find clients, set up a partnership, hire a trader, find a place to work, and begin the investing process. Hmmmm, now that I think about it, maybe setting up a fund is not that easy after all.