Investment professionals can create machines with fancy algorithms for trading and snazzy software for picking stocks to protect portfolios, but Jim Cramer knows investing all boils down to one word: diversification.
"I am offering a new kind of diversification that can help you, guide you toward what kinds of stocks I want you to have if you are going to manage your money yourself," the "Mad Money" host said.
Cramer recommended a personal portfolio with a minimum of 10 stocks and maximum of 15. That range allows investors to keep track of each stock and still do their homework.
In order to protect your portfolio, Cramer recommended covering the following five specific areas:
2. A dividend-paying stock with a high yield
3. Growth stocks
4. Speculative stocks
5. Stocks from a healthy geography
"Cover all five bases, and you'll have a portfolio that can win in any market," Cramer said.
The first stock Cramer recommended is a dividend-paying stock. After all, interest rates are headed higher whether we like it or not, he said. In a world where you cannot get enough income from bonds or certificates of deposit to really live on, a stock with a high yield is necessary.
"You need to own a stock — at least one, possibly more — with a big, high-yielding dividend, but unlike when we diversify by sector, owning two or even three high-yielders, but no more than that, can actually be a good thing," Cramer said.
That doesn't mean investors should own five dividend stocks, as then they would not be protected in the event that long-term treasury bond yields spiked higher to compete with the dividend stocks.
So in order to embrace Cramer's new way of diversification, a high-yielder is necessary. Dividends protect stocks and are a great way to add profits into your pocket. It's a win-win.
Growth stocks come next. But how can you tell if a stock is, in fact, a growth stock?
Use basic algebra — that's how to tell. Here's the methodology that Cramer uses:
"The share price, P, equals the earnings per share, E, times what's known as the multiple, M," Cramer said. In other words, "E times M equals P."
"The multiple is the key. It tells us what investors are willing to fork over for a company's future earnings. And the most important factor influencing multiple is the company's growth rate," Cramer said. "The Street will pay a bigger multiple for businesses with faster growth because that growth means the earnings will get larger and larger in the years ahead."
What does a healthy geography mean? Previously, Cramer would have recommended adding foreign exposure to a portfolio. But now that he has seen the damage left behind from Europe, China and the emerging markets, he tweaked that definition.
"What you really need is a stock that is in a safe geography. At times, when the United States is growing more slowly than the rest of the world, you need something international — and not just something that does a lot of business overseas," he said.
Cramer means a company actually headquartered in a foreign country. The "Mad Money" host referred to a safe geography because foreign stocks are not always a good idea.
Cramer always talks about specs, but what exactly does he mean?
These stocks present higher risk, but also offer higher reward. Something to keep you interested!
When compared with the standard fare in Cramer's other strategy — think dividend yields and growth stocks — a high-risk stock hardly seems to make sense. Speculation always seems to be that dirty little word investors are told to avoid.
"Not only is it okay for you to own those tempting, risky, broken-seeming stocks that trade in the single digits, it's a necessity, as long as you follow my rules and speculate wisely," the "Mad Money" host said.
Gold brings a special element into a portfolio, one that makes it different from all other metals. However, Cramer warned this one should not make up even 20 percent of an investor's portfolio. That is way too much.
"I think that 10 percent is the upper limit because I consider gold as an insurance policy, and no worthwhile insurance policy should be 20 percent of the money you have invested," the "Mad Money" host said.
Granted, this may sound like a terrible idea since gold has not done anything spectacular in a few years. However just as you wouldn't own a home or car without insurance, you shouldn't have a portfolio without gold, he said.
Do you get upset when your insurance doesn't go up in value? No. So, don't ridicule gold.
Owning gold is not about upside potential. It is about minimizing risk to the downside. (Tweet This)