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Editor's note: The following is a recap of a "Mad Money" episode that originally aired Dec. 27, 2006.
In order to beat the market, investors "need to know a handful of extremely important rules" and "unlearn some of the worst, most harmful myths that all too many people seem to believe about stocks and investing," Jim Cramer told viewers of his "Mad Money" TV show.
When he was a money manager, despite having a "terrific track record," Cramer said, he made every single mistake in the book -- that book being
Jim Cramer's Real Money: Sane Investing in an Insane World
. He said he's also made every mistake featured in his latest book,
Jim Cramer's Mad Money: Watch TV, Get Rich
Out of these, the "single worst and most common mistake" people tend to make regarding stocks is buying and holding them, he said. Buy and hold isn't a strategy but rather an ideology based on the belief that if you buy a stock and hang on to it for long enough, you'll make money, Cramer said. Although it is a comforting theory that allows market players to be lazy, "it's just not true that your stock will necessarily bounce back," he went on to say.
"The only way you can really know if your stocks are going up is by doing the homework," Cramer said. "Buy and homework, not buy and hold."
While homework might not seem like fun, if people don't do it they are setting themselves up for losing a lot of money, he said. When Cramer first started investing in the stock market, he said, he believed in buy and hold, but then he realized there was "something irresponsible and stupid about it."
Buy and hold might have made sense 30 or 40 years ago, "when taxes were high and commissions were even higher," he continued. But now it's a "form of false consciousness that stands between you and your ability to make money."
On the other hand, if market players study up on the stocks and do their homework, they'll be prepared and know when it's smart to buy and when it makes sense to sell, Cramer said. For those people who don't have time to do their homework on a stock before they buy and while they own it, he suggested they put their money into mutual funds instead.
Don't Dwell on Regrets
The second worst mistake people make when they invest is harboring regrets, he continued. In his
book, Cramer made this rule No. 13: "
There are no woulda, shoulda, couldas." And even though people know it's unproductive and bad to dwell on missed opportunities or past mistakes, they still do it, he said.
"Every second that you spend wistfully wishing you'd made different decisions is a second wasted," Cramer said. "It's just human nature: We want lots of money, and when we miss an opportunity or make a mistake, we can spend hours or even days beating ourselves up over it."
In fact, Cramer said he's the worst trespasser when it comes to this rule. When he worked at a hedge fund and got something wrong, he'd "just sit there, totally mesmerized" and totally hating himself, he said. But market players "cannot afford to get thrown off their game" like that.
"So you need to be proactive," Cramer said. "When you make a mistake that you can't stop thinking about, you need to make sure you don't get mired down thinking about how you made such a bad decision."
Instead of thinking about the past, think about the future, as that's the only way to make money, he said. And second, don't let the mistake weaken your confidence.
Tips: For Waiters, Not Traders
The next rule is "tips are for waiters," Cramer said. He said he knows people like to get "hot stock tips" and "make easy money," but there's no such thing as a stock tip, and "you have to discipline yourself so that you never, ever take a tip seriously."
For example, if there is a person that gets a tip from a friend that
wants to buy
Research In Motion
, "alarm bells should start ringing" in that person's head, Cramer said.
The only way the tipster could know that would be if he's an insider, and if an insider tips you off to the deal before it's announced, he's breaking the law, he said.
Securities and Exchange Commission
investigate you is pure hell even if you haven't done anything wrong," Cramer said. "Imagine how bad it would be if you were actually guilty of something."
However, if the tipster is not an insider, then there's no way he could know that Nokia's going to try to take over RIM, he went on to say. And getting a tip from somebody who doesn't know anything is "worthless."
People would love to get a real tip, but "those don't exist," Cramer said. "If you get a tip, it's either illegal, incorrect or straight-up manipulative."
Moving on, Cramer said that while people want to be diversified in theory, when they go off and actually pick stocks to invest in, they often decide they don't really want to be diversified in reality because it's "boring, conservative and totally unsexy."
"I like to think that I'm universally loved, but people really tend to hate me when one sector is
and I tell them to take some money out of it and spread it around because you can't keep all your eggs in one basket," Cramer said. "But when the party's over and that sexy sector falls out of favor," all of a sudden people thank him profusely for keeping them diversified.
Keeping a diversified portfolio means never having more than 20% of one's investing money in a single sector, he explained. While no fun, diversification is "essential" for those serious about investing.
The urge to throw all of one's money into one hot sector is "wrong" and "can ruin you," Cramer warned. "You absolutely must stay diversified, and this rule can't be bent, broken or spindled."
Invest in Steps, Not Leaps
Moreover, if people want to be good investors, they need to refrain from getting too arrogant, he said. "Arrogance is a sin" that will always lose people money.
"The single most arrogant thing you can do as an investor is buy your whole position in a stock at once," Cramer said.
This is something investors should never do. Instead, he said, the "smart and humble thing to do" is to buy incrementally and "patiently wait for good entry points as you gradually build up your position."
People who buy a position all at once generally end up feeling stupid most of the time, and even worse, they end up making less money than if they'd been patient and bought incrementally.
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