Every week on this show Cramer plays “Am I Diversified?” with loyal Home Gamers. Now, pretty much everybody agrees in principle that diversification is great. Everybody wants to be diversified in theory, but it's not as sexy as going all in on a winner stock. Diversification is boring. It’s conservative. It limits your risk. It’s totally unsexy. Diversification is the biggest party-spoiler in the world of finance.
Cramer understands. When housing is rallying, of course people want to throw all of their money into that one really strong sector. But think about those people who were ruined because they owned too much tech when the bubble burst just a few years ago – or the Enron employees who lost everything because they only owned stock in their employer and then that went to zero.
Keeping a diversified portfolio – which means never having more than 20% of the money being invested in a single sector – is essential if someone is serious about investing. Over the long term, diversified portfolios perform better than undiversified ones, Cramer said.
The problem is that people just are not good at processing downside risk – that’s just how people are programmed. They don’t intuitively understand that if they throw all their money in one sector, they could lose it all. It’s hard to feel that some of the stocks they own, especially those they like best, could be headed straight to zero.
In this situation, feelings always lose. Investors absolutely must stay diversified, and this rule can’t be bent, broken or spindled.
Questions? Comments? madcap@cnbc.com
Questions, comments, suggestions for the Mad Money website? madcap@cnbc.com