Jim Cramer: Single Most Important Investing Concept

Cramer's Metal Play For Chaotic Times

Mad Money host Jim Cramer explains why one of his favorite ways to play gold is with the GLD, over the gold miners.

If you're trying to navigate the market and having a hard time, Jim Cramer has one word for you.

Diversification.

"This is the single most important concept in investing," he said. "It's the key to avoiding enormous losses and making sure you can weather a storm."

The idea behind diversification is critical whether you own 5 stocks or 500. That is, diversification spreads out risk and therefore helps shareholders mitigate negative developments.

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"When you get too concentrated in one area, should something bad happen, you're going to want to throw yourself off a bridge because the losses will be enormous," Cramer said.

"However, if your portfolio is properly diversified, then you can handle just about any setback. You can even come back from financial disaster," he added.

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Achieving diversification involves following a rule – one that's simple but sometimes also painful. That is, to be properly diversified, you must only ever keep 20% of your portfolio in stocks of the same sector.

No matter how tempting it may be to make a big bet on banks as the economy turns or jump on retailers into the holiday season, you must exercise restraint. Only ever allocate a fifth or less of your portfolio to a single thesis – no matter how sure-fire you think it is.

"That means if you own 5 stocks, only one of them can be a tech stock, only one can be a health care stock, only one can be a financial, only one can be an energy company, only one can be an industrial," Cramer explained..

And if you're not sure, Cramer says err on the side of caution – diversification is that important.

That is, "If two stocks trade together, if the underlying companies succeed or fail based on the same factors, then you are not well diversified," Cramer said.

Although riding a momentum wave may feel good on the way up – it feels terrible on the way down.

Diversification demands self control, so that when something goes wrong unexpectedly, you're much less likely to lose your shirt.

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