Your Real "Real Money"

June 15, 2009 by
Filed under: Finances, Technology 

Jim Cramer's real money
Jim Cramer's real money: sane investing in an insane world
Jim Cramer; Simon & Schuster 2005
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Cramer writes as he speaks: a little too cocky, self confident, straightforward, candid, and with a couple of “insider” jokes that make you think he is the only one that finds them funny. It is a great flight book (that is a book to read on a boring 6 hour flight). That being said, the book is a good collection of sane (yes, I said sane) advices for the novice and no so novice investor. His stock-picking rules are a good organized way to summarize the basics of disciplined investing / trading. I have two pet peeves on his recommendations: the way he defines diversification (which is not exclusive of Mr. Cramer), and the 5 stock limit for part time investors. Let me explain.

I am not saying that you shouldn’t diversify, but diversification is different for each investor. If you call his show to the “am I diversified” segment and tell him: “I own EBAY, GOOG, AAPL, CSCO, and QCOM” i can hear the screams all the way from here: “They are all tech!!, are you crazy????” The firs statement is true, the second … well, I don’t know for sure, but not because you own those stocks. EBAY is really online retail, Google is advertisement; Apple devices; Cisco, infrastructure, and Qualcomm, chips. True, there may be some correlation between them, especially between QCOM and AAPL (iPhone uses silicon chips). But based on fundamentals they really address very different markets and their revenues are not so closely tied. Technically, they might be closer since most investors aren’t tech geeks so they think they are tied together more than they really are. If you work in tech like I do, you can distinguish the differences between these sub-categories and be diversified within a sector. Moreover if you work in tech you have to monitor these companies.

Cramer also suggests to own a minimum of 5 stocks to consider diversified, and he even goes through rules of how to pick the categories of these 5. He also suggests that more than 5 is too many due to the “buy and homework” strategy, arguing that you can’t devote enough time to do homework on more than 5 stocks and still have a day job. My opinion is that like everything else in life it depends. Following on my example above I have to know about the 5 companies I highlighted below for my day job, so I can afford to own stock of more than 5 if I can dedicate my moonlight hours to do “homework” outside of my area of expertise.

One last comment: I think Cramer overlooks one additional cardinal rule of investing. That is keep a balanced portfolio. Diversification doesn’t mean a lot if you own 5 stocks but 80% of your portfolio is in only one. Index funds that follow the Dow Jones or S&P are another fallacy of proper diversification like I explained here.