Putting Cramer in Context

Friday, 15 Aug 2008 | 7:18 PM ET

This week we featured four biotech stocks -- Onyx, Genzyme, Vertex and Alexion -- so this seems like a good time to talk about the context of all of Jim's recommendations on the show.

If you watched or read the recaps, you know the series was more about the fact that Jim thinks biotech is one of the best sectors where you can park your money in this market. So again, this is about a theme, not about the individual stocks. We may have said all four biotechs are buys, but anyone who puts all four of these stocks in their portfolio is nuts.

Every stock, every theme we talk about, you have to take all of them in the context of a diversified portfolio. If you already own a biotech stock that you like better than the four we highlighted, good for you. If that's the case, you don't want to add another biotech name --
not Onyx, not Genzyme, not Vertex, not Alexion. Buying them would entirely defeat the much more important purpose of diversification.

Let's go over the rules quickly: To be diversified, no more than 20% of your portfolio can be in any one sector, meaning you need to own a minimum of five stocks to be diversified. Throw in Jim's law of time and inclination (it's called Cramer's law of time and inclination in
the books, but I reserve the right to always use the first name of anyone who changed my diapers as a baby), which says you shouldn't own individual stocks if you can't spend at least one hour of homework per week per stock. Therefore an individual investor with a full
time job shouldn't own more than ten stocks at any one time. That should give you some idea of the context of every stock pick on Mad Money.

Since Jim's so bullish on biotech, it would make sense to put 20% of your portfolio into one of the biotech names we recommended this week (although not Alexion if you already have something speculative in your portfolio), or another biotech of your choosing, but no more than
that. If you're running a 10-stock portfolio, you could get away with owning two biotech stocks in this environment, but together they can't make up more than 20% of your holdings. And don't get cute. In a five-stock portfolio you can't own one big pharma stock and one biotech stock. The groups don't always trade together, but putting two-fifths of your holdings into companies that make drugs is not diversification.

Taking a step back, this goes for everything we recommend. Do you already own a stock in the same sector as the one Jim's talking about? Weight the two against each other, but keep in mind that in most situations, you can't own both. If we spend a week talking about
just one group, like we did this week, then you might want to increase your exposure to that group (as long as you agree with Jim's thesis and have done your homework, etc.), but to no more than that 20% ceiling.

And let me just throw this in as a somewhat tangential aside: If everything you own is going up, it's time to reevaluate your portfolio because you've done something wrong, you're not diversified. You may own five stocks we've suggested on Mad Money, but you still have to get rid of at least one of them even if neither you nor Jim think it's a sell. When Jim says discipline always trumps conviction, this is what he means: You don't violate these rules no matter how much you like a stock or sector.

Cliff Mason is the Senior Writer of CNBC's Mad Money w/Jim Cramer, and has been that program's primary writer, in cooperation with and under the supervision of Jim Cramer, since he began at CNBC as an intern during the summer of 2005. Mason was the author of a column at TheStreet.com during 2007, which he describes as "hilarious, if short-lived." He graduated from Harvard College in 2007. It was at Harvard that Mason learned to multi-task, mastering the art of seeming to pay attention to professors while writing scripts for Mad Money. Mason has co-written two books with Jim Cramer: Jim Cramer's Mad Money: Watch TV, Get Richand Stay Mad For Life: Get Rich, Stay Rich (Make Your Kids Even Richer). He is 100% responsible for any parts of either book that you did not like.

Mason has also had a fruitful relationship with Jim Cramer as his nephew for the last 23 years and will hopefully continue to hold that position for many more as long as he doesn't do anything to get himself kicked out of the family.

Questions for Cramer? madmoney@cnbc.com

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