- "Mad Money" host Jim Cramer explains a key concept he learned in his early days of investing.
- Risk tolerance matters to individual investors, which is why suitability is so critical, he says.
- Cramer also shares why buying stocks does not have to be a "caveat emptor."
There used to be a widespread understanding in the stock market that stocks could be here today and gone tomorrow, but CNBC's Jim Cramer finds that that's not the case anymore.
"We've gone well beyond that," the "Mad Money" host said. "Those days are long over, and if you recommend a stock for a trade, even if you say, 'Buy it today for the analyst meeting and sell it tomorrow,' there will always be a YouTube video kicking around that shows you liked the stock but never gave it the 'sell' call."
That is why Cramer wanted to explain the concept of suitability — an idea that suggests certain stocks are right for some investors, but wrong for others.
Cramer first heard about suitability when he started working at Goldman Sachs as a summer intern for the group helping small businesses and individuals.
He had already been buying individual stocks for himself and others for five years before he started at Goldman, even setting up answering machines messages recommending various stocks to buy.
Not long after Cramer got the Goldman position, an employee from the firm contacted him, got the answering machine message, and told Cramer to call him as soon as possible.
"He asked me if I knew what suitability was. I had no idea. So he introduced me to the concept," Cramer said. "He asked me: Did I ever consider that many people who called me and got my answering machine might not be ready for the stock of the hottest semiconductor company in the land, and that I was recommending it to them one-on-one without any sense of it was right for them?"
Cramer replied that he thought it was obvious stocks came with no guarantees, a "caveat emptor" situation. Caveat emptor refers to the idea that buyers are solely responsible for verifying the quality of items before purchasing them.
The executive explained the worth of knowing what an individual investor wants based on what he needs out of a stock and the risks he is willing to take while investing.
That opened Cramer's eyes to the importance of risk tolerance. Clothes, cars, devices and houses either come with some level of insurance or can be returned. Stocks cannot.
"You buy a share of Nike and the next day Goldman Sachs downgrades it and the day after Foot Locker says there's been a slowdown in Jordans. You can't go back to your broker and say, 'Hey, chief, you never told me this could happen. I'm down $3 on 2000 shares. I'm out $6,000. I want that six grand. I want it back," Cramer said.
There is no real insurance when it comes to stocks, except for complicated and expensive put options, which give owners the right to sell their shares of a given stock when it hits a particular price, Cramer explained.
These days, all electronic brokers do in the way of protecting investors from risk is give them a form to sign saying they know what they are getting into and accept responsibility.
"That stops here," Cramer said. "Caveat emptor? No, just 'buyer be a little more aware' of what you might be committing your hard-earned dollars to when you pull the trigger on a buy."