Mad Money

Cramer’s Rules for Long-Term Investing

The idea of long-term investing has become confused with lazy and apathetic investing, Cramer says. And you might not be adequately prepared for retirement, your kids’ college tuition or buying a new home if you don’t keep a watchful eye on your portfolio.

A lot of people think they can simply own a basket of stocks and forget about them. They embrace the idea of “buy and hold,” the investing strategy championed by none other than Warren Buffett, which says that any losses incurred in the short term eventually will be made up in the future. But if there’s one thing the crash of 2008 taught us, it’s that the opposite is true. Lack of vigilance can put a huge dent in your portfolio.

So, “buy and hold is dead,” Cramer said, because “it’s an easy way to lose, not make, money.”

But that doesn’t mean long-term investing is dead. In fact, the two are entirely different things – the former is passive, while the latter is active. And people who actively manage their money stand a much better chance of building sustainable wealth for themselves and their families.

How do you take control of your portfolio? Do the homework, Cramer says. Read the Securities and Exchange Commission filings, review the quarterly reports and pay close attention to company conference calls. And rather than simply buying and forgetting, look for stocks that work for 18 months or more, depending on your goals. Then monitor them constantly, looking for any change that affects the reasons why you bought them in the first place. If your thesis isn’t working anymore, then it’s time to take profits.

There also are a few other maxims you should keep in mind...Click here for Cramer's 4 Rules for Long-Term Investing.

There also are a few other maxims you should keep in mind, namely Cramer's four rules for long-erm investing. Whether it’s finding tradable trends, buying or selling a position or owning the right stocks in your retirement accounts, these rules should help generate the most money possible for your future. Read on for those, and be sure to click through Cramer’s “5 Picks for Retirement Investing.”

Generational Moves

One of the best ways to build a sizable nest egg, without suffering much of the short-term volatility inherent in the markets, is to look for the best secular growth trends, or those not dependent on the economy for their success. Luckily for you, one is happening right now.

Regular viewers of Mad Money know that Cramer has been talking up the mobile Internet, or, as he calls it, the smartphone revolution. The mass adoption of these all-in-one handsets, which offer everything from voice to video, is a trend on par with the rise of the Internet in the early 1990s and the personal computer 30 years ago. These devices aren’t a luxury anymore, they’re a necessity. And they’re only going to grow in importance from here.

Now, the most obvious play on the mobile Internet, at least as far as Cramer’s concerned, is Apple and its revolutionary iPhone. Not only is this one of the best-run companies in the US, but it’s “an innovation machine with supercharged growth.” But there are a number of related stocks that work as well, as the popularity of smartphones ripples out to the entire industry. In addition to AAPL, networking infrastructure outfits like Cisco Systems , chipmakers like Qualcomm and even telco carriers like Verizon Communications all would make great additions to your portfolio. (At publish time, Cramer’s charitable trust owned Apple, Cisco Systems and Qualcomm.)

Admittedly, moves like the mobile Internet are rare. But...Click here to learn Cramer's strategies for "scaling" into stocks.

Admittedly, moves like the mobile Internet are rare. But not so much that they don’t strike a couple of times a generation. When they do, take advantage.

The Price Is Right

When investing for the long term, time is on your side. So there’s no point to rushing in, Cramer says, when you can afford to wait for the right price. 

That said, calling the absolute bottom in a stock is virtually impossible. Even Cramer, after decades of Wall Street experience, rarely gets one right. The strategy then is to buy your shares in increments as the price declines. He calls it “scaling” into a stock, and it’s a great way to build a position.

Here’s an example: Caterpillar is trading at $55, and you want to buy 400 shares. If you buy the whole position at that level and CAT later drops a few points, then you’re going to feel, well, stupid. Instead, Cramer recommends 100 shares at $55, another 100 at $53, the next century at $51 and the last quarter at $50.

Specifically, Cramer said he likes to use wide scales. In this case, you’d buy larger and larger positions as the stock goes lower. So, going back to Caterpillar, you’d buy 25 at $55, 75 at $53 and so on. When CAT is lower than you ever thought it would be, double down. This strategy leaves you room to pour your money in when the stock is nearest its bottom.

Of course, this applies only to broken stocks headed lower, not broken companies...Click here to learn how to take profits the right way.

Of course, this applies only to broken stocks headed lower, not broken companies. So make sure you aren’t buying a loser.

And if you’ve picked a winner, but the share price goes up after your first purchase. At least you still own some and you’re collecting some profits.

“I regard that as a high-quality problem,” Cramer said.

Know When to Fold ‘Em

Knowing when to sell is just as important as knowing when to buy, Cramer says. Don’t believe him? Then just look at all the people who’d made tons of money on tech stocks through 1999, only to lose that cash in 2000.

You should take profits even on your winners, such as those mobile Internet names, because, as Cramer always says: Bulls make money, bears make money, hogs get slaughtered. And a rising stock could grow until it comprises too large a piece of your portfolio. At that point, you’re no longer diversified, and that’s a dangerous place to be.  Cramer says no stock should comprise more than 20% of your portfolio at any time.)

So what’s the best way to sell a stock? The same way you bought it – in increments. As the share price rises, take profits at different price levels. The goal is to have recovered your initial investment in that particular name and have only “the house’s money,” or your gains, still in the market. That way you can afford to take more chances with what’s left.

Oh, and keep this in mind...Click here for Cramer's strategies for retirement investing.

Oh, and keep this in mind: Younger investors may let their winnings ride longer than those closer to retirement. Let’s face it, older investors can’t risk the wealth they’ve built up to that point. Therefore, they have to be more careful.

Saving for the Golden Years

The last of Cramer’s long-term investing rules speaks directly to retirement.

Sure, you’ve heard the basics before: Contribute to your 401(k) and make sure you have an Individual Retirement Account, or IRA. But here’s the main reason why: both are tax-blessed vehicles. The money you put into them are pre-tax contributions, and you don’t pay taxes on your profits until you make a withdrawal. And even then it’s taxed just once, as regular income.

Most 401(k) plans “stink,” Cramer says. They have high management fees and administrative costs that eat into you returns, and they offer few good choices for investing your money. Typically they’re just mutual funds and bonds, not the kind of active investing that he advocates. But you should still take advantage of your 401(k), if you have the option. Cramer recommended putting in only what your employer will match – because it’s free money – and then placing the rest of your retirement money in an IRA.

IRAs are better, Cramer says, because they let you invest your money however you’d like. That’s why he recommends maxing out the contribution limit for a given year. And to best capitalize on the account’s tax-preferred status, seek out high-yielding dividend-paying stocks that offer as much safety as possible. Cramer specifically mentioned master limited partnerships (also known as energy trusts), oil tanker stocks and real estate investment trusts. (Click here for his 5 Picks for Retirement Investing.)

“These are companies with bountiful dividends that you can reinvest so they compound for years and years,” he said, “giving you amazing long-term returns. [They are] perfect for when you ultimately do retire.”

At publish time, Cramer’s charitable trust owned Apple and Cisco Systems.

Call Cramer: 1-800-743-CNBC

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