There’s a reason certain money advice is considered classic. Almost every financial advisor will advise you to build and maintain an emergency fund or invest enough in a workplace retirement plan to get matched by your employer. This is because it is a reasonable course of action for almost all clients.
For many investment professionals, building a portfolio from low-cost index funds falls into that category. The idea is that by matching the returns of a broad stock market index, the average investor will have an advantage over the long term over professional investors trying to beat the market. Over the 15 years ending June 30, only 12% of actively managed funds that track large U.S. company stocks outperformed the S&P 500, according to S&P Global.
But Jim Cramer doesn’t want you to be an average investor. In his new book, “How to Make Money in Any Market,” the host of CNBC’s “Mad Money” offers what he calls a “radical” plan to help readers build long-term wealth.
“Let’s free ourselves from the rigid, tried-and-true approaches that keep us chained to half-baked profits,” he wrote.
Rather than an index fund-only approach, Kramer says you should divide your portfolio into three parts.
“I want individual stocks, I want index funds, and I want a little bit of gold or crypto,” he told CNBC Make It. “Then I think you have the ability to retire much earlier than others.”
Here’s how things break down:
1. Index funds
Mr. Kramer doesn’t completely deviate from investment orthodoxy. He still recognizes the need for low-cost, widely diversified investments.
“Wealth-building portfolios need to include a lot of index funds,” he says. “I think it’s okay to invest 50% in an index fund.”
His reasoning is that funds that track indexes such as the S&P 500 or Nasdaq 100 provide a kind of anchor for riskier parts of a portfolio. By investing in hundreds of stocks, you reduce the chance that a sharp decline in any one stock will derail your entire strategy.
“We need to be firmly entrenched in diversification as an insurance policy against picking a few wrong stocks,” he writes in his book. “You’re going to make mistakes with some of the stocks.”
2. Individual stocks
Cramer says that to build wealth, you need to go beyond index investing and branch out into individual stocks.
“I hate averages, even though I accept them as a necessary evil in a diversified portfolio,” he writes in his book. “Are you proud of being average in the rest of your life? Did you buy the book Making Money the Average Way by Average Joe? The S&P is average.”
To outperform the index, Kramer suggests building a portfolio of five individual stocks so that the sum is approximately equal to the amount invested in the index fund. Mr. Kramer envisions a 50/50 split between these two parts of the portfolio, or more precisely something like 45/45, with the remainder reserved for a third type of investment.
The majority of stocks should be high-quality growth stocks, he says. These should be companies that can be expected to have consistent growth over many decades, he says. That means companies with growing revenues, innovative products and services, and a durable competitive advantage over their peers.
If you’re young, Kramer says, one or two of your five stocks should be more speculative — stocks that have the potential for very high returns but come with significant risk of loss. These stocks have the opportunity to deliver needle-moving returns that can significantly increase your wealth, Cramer says.
And if you go bankrupt, he says, “you’re young and you have a lifetime to make that money back.”
Kramer says all stock picking should be based on basic research that is checked regularly. At the very least, he says, you should listen to the quarterly earnings reports of companies in which you own stock.
“A casual observer can spend four hours a year on individual stocks,” Kramer says. “If you can’t do that, you should default to an index fund.”
3. “Insurance” assets
Mr. Kramer argues that a small portion of your assets should be used as a hedge or insurance against other investments.
“My point is that it is likely to perform independently of the stock market, and a large drop in the stock market will not necessarily crater,” Kramer wrote.
His two favorites are gold and Bitcoin.
Kramer recommends holding 5% to 10% of your portfolio in one of these assets. That’s not because we expect those assets to make you rich, but because they can be held as a store of value in the event of disaster elsewhere in the market.
Cramer argues that a sudden rise in national debt, for example, could ultimately be highly destructive to the economy. According to Kramer, making an investment that has the potential to make a profit in such a scenario is like insuring your home. I hope I never use it, but it gives me peace of mind to have it there.
“Unlike speculators who buy gold or cryptocurrencies and hope to get rich, we are simply using them to weather the storm,” Kramer wrote. “We’re going to make a lot of money investing in stocks. This hedge will just let us sleep at night.”
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