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Editor's note: This recap was last published on July 22, 2011.
NEW YORK (
) -- When it comes to investing, "arrogance is a sin," Jim Cramer told the viewers of his "Mad Money" TV show Friday, as he laid out some new rules to help home gamers better manage their portfolios.
Cramer said at some point, something is going wrong with your portfolio, some thing you never saw coming, and that's why being prepared is the name of game. How should investors get prepared? Diversification.
Cramer has long preached the merits of diversification, making sure that a single stock, or sector, doesn't represent more than 20% of your portfolio. "Err on the side of caution," Cramer told viewers, and you'll be protected when President Obama attacks healthcare, or when financial reforms rock the bank stocks.
Cramer said if investors cover all their bases, they'll have a portfolio that can win in any market. But diversification, he noted, also goes beyond the world of just stocks. He said that managing a well diversified portfolio is not just about managing the upside, but also limiting the downside, and that means investing in gold.
Investing in gold can take many forms. Cramer said the easiest way is with the
SPDR Gold Shares
ETF. While gold miners, like
can, from time to time, screw things up, the gold ETF is the safer way to play.
That's not to say gold miners aren't great stocks, noted Cramer, investors just need to do their homework before owning them. But no matter how you invest, gold should always be part of a well-diversified portfolio.
Add One Speculative Stock
So once investors have committed themselves to having a well-diversified portfolio, how many stocks should they own? Cramer said a good portfolio should have no less than five stocks, but unless you're a professional money manager, you should own no more than 10.
Cramer said every stock in your portfolio deserves at least one hour of homework per week. So unless you have the time for another part-time job, 10 should be the maximum. Less than five, he said, and you're just not diversified.
Another tip for investors, always own at least one speculative stock. Cramer said the word speculation may be a dirty word on Wall Street, but speculating is a healthy part of any portfolio.
Cramer said just as gold protects investors from boredom, speculation protects you from boredom. He said it can not only keep you interested, but if done wisely and with the right rules and discipline, can generate enormous gains as well.
Choosing the right stock to speculate on can be tricky said Cramer. The key is to pick a broken stock, and not a broken company. No company's stock falls below $10 a share because things are going well, said Cramer, but sometimes, stocks can be hated, and mis-pricing can occur.
That's what happened to
at $4 a share in 2009, and
Bank of America
, a stock, which he owns for his charitable trust,
Action Alerts PLUS, at $3 a share.
"Lots of fantastic stocks started as speculations," said Cramer, "just because a stock trades at $3 doesn't mean it's three-card monte."
Being diversified means more than just picking stocks from different sectors, Cramer told viewers, it means choosing stocks based on different strategies as well. He said in addition to keeping a place in your portfolio for gold, investors should also always have a growth stock in their midst, specifically a secular growth stock.
Cramer explained that a secular growth stock is one that's growing despite the health of the overall economy. He said stocks like
, another Action Alerts PLUS name, along with
Chipotle Mexican Grill
are all great examples of companies with strong secular growth.
How much should investors be willing to pay for these high flying growth names? Cramer said a good rule of thumb is that a stock can trade up to twice its long-term growth rate before it gets too expensive. So for a stock growing at 20% a year, investors should be willing to pay up to 40 times earnings for its shares.
Cramer said investors need to also keep an eye on the earnings estimates for these growths stocks as well. If the estimates are continually being raised, the stock is likely in great shape, but if growth slows, or the company misses an estimate, the stock will suffer the consequences.
High-Yielding Dividend Stock
What's the next piece of a well-diversified portfolio? Cramer said its a high-yielding dividend stock. He said while dividend stocks might not be as sexy as a high flying tech stock, they work.
Since 1926, about 40% of the return from the
has come from dividends, he said, a fact that few investors realize. He said dividend stocks are not just about safety, they're also about capital appreciation through the compounding reinvestment of those dividends.
Cramer said "accidental high yielders," stocks yielding over 4%, are great stocks to own, as are the stocks of companies that have recently raised their dividends, the ultimate sign of strength and confidence in their business.
Be wary of stocks with dividend that are too high however, warned Cramer. He said that sometimes a high dividend can be a red flag. Cramer said his rule of thumb is that a company must earn at least twice its dividend payout for him to consider that dividend safe.
"Dividends protect your stocks," Cramer told viewers, and since there's a terrific way to make money as well, "what's not to like?"
Cramer said the final piece of the diversification puzzle can't be found here in the U.S., it can only be had overseas. He said every portfolio needs a genuine international company, because the U.S. is now the caboose of the global economic love-train.
"We're lagging everyone from China, to Latin America, to India and Germany," said Cramer, and that's why owning one foreign stock is pretty compelling. He said investors need not speculate on an exotic Chinese stock, they can choose from some great Canadian stocks, which are closer to home.
Cramer said the country doesn't really matter, as long as it's not here. If investors are going to build a portfolio that works in any market, they simply cannot put all of their stock eggs in just one government's basket.
--Written by Scott Rutt in Washington, D.C.
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Jim Cramer, host of the CNBC television program "Mad Money," is a Markets Commentator for TheStreet.com, Inc., and CNBC, and a director and co-founder of TheStreet.com. All opinions expressed by Mr. Cramer on "Mad Money" are his own and do not reflect the opinions of TheStreet.com or its affiliates, or CNBC, NBC UNIVERSAL or their parent company or affiliates. Mr. Cramer's opinions are based upon information he considers to be reliable, but neither TheStreet.com, nor CNBC, nor either of their affiliates and/or subsidiaries warrant its completeness or accuracy, and it should not be relied upon as such. Mr. Cramer's statements are based on his opinions at the time statements are made, and are subject to change without notice. No part of Mr. Cramer's compensation from CNBC or TheStreet.com is related to the specific opinions expressed by him on "Mad Money."
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Some of the stocks mentioned by Mr. Cramer on "Mad Money" are held in Mr. Cramer's Action Alerts PLUS Portfolio. When that is the case, appropriate disclosure is made on the program and in the "Mad Money" recap available on TheStreet.com. The Action Alerts PLUS Portfolio contains all of Mr. Cramer's personal investments in publicly-traded equity securities only, and does not include any mutual fund holdings or other institutionally managed assets, private equity investments, or his holdings in TheStreet.com, Inc. Since March 2005, the Action Alerts PLUS Portfolio has been held by a Trust, the realized profits from which have been pledged to charity. Mr. Cramer retains full investment discretion with respect to all securities contained in the Trust. Mr. Cramer is subject to certain trading restrictions, and must hold all securities in the Action Alerts PLUS Portfolio for at least one month, and is not permitted to buy or sell any security he has spoken about on television or on his radio program for five days following the broadcast.