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Jim Cramer's Stay Mad For Life Get Rich, Stay Rich (Make Your Kids Even Richer) by James J. Cramer with Cliff Mason Jim Cramer has been poor and has been rich. At one time he was so broke that, for six months, he lived in the back of his Ford Fairmont. Today he is a self-made multi-millionaire, best known for his boisterous CNBC TV show Mad Money. En route from one life stage to the other, he was also a successful stockbroker at Goldman Sachs and later the manager of his own, hugely prosperous hedge fund, Cramer, Berkowitz, that returned more than 20% a year for its wealthy investors. The remarkable thing is that even when he was living in his car, Cramer, then a homicide reporter in Los Angeles, always managed to put something away. Driven by his determination to succeed and be rich, he lived frugally and saved whatever he could. And now, he says, he can make the rest of us rich — if we just follow his formula. Labeled by USA Today as "the media's most electrifying pundit," he describes himself as "a generalist who takes pride in knowing more stocks than anyone in the universe." He is famous for the quick-fire responses and histrionics of his entertaining, daily show which is the most popular investment program on TV. What people may not know is that because of his TV contract, he is not permitted to invest in the stock market. And why should he worry, he asks, having already made more money than he'll ever need? He quit his hedge fund at the top because he thought the unremitting pressure was going to kill him and devoted his time, energy and investing obsession to the print and broadcast media, the website TheStreet.com (which he co-founded), and a trust through which he channels his stock-buying passion and which gives all its profits to charity. His mission now is to show us the route to enduring prosperity. Getting rich isn't the financial finish line, he declares. It's the first lap of a longer race that involves holding on to and continuing to grow your wealth. "I want you to get there and stay there," he pledges. His collaborator for the book, Cliff Mason, is head writer for the Mad Money TV show and a staff writer at TheStreet.com. Getting the Basics Right Cramer's strategy is based on achieving the right balance between capital appreciation and capital preservation in the various stages of life. As we get older, 1
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it becomes more important to preserve what we've got than to risk our savings in pursuit of growth, though he suggests there should always be room for some speculative investment. Preservation, though boring in Cramer's view, is usually the more important because it's directed towards necessary expenses like retirement, your home or perhaps college tuition for your kids, and you need a portfolio to support this. A second, discretionary (and more risky) portfolio enables you to invest for capital appreciation and riches today. Whatever your approach, the starting point is always the same — the need to save. But although that's a simple enough notion, it goes against the grain for many of us because we look at saving the wrong way. We think of it in terms of self-denial and self-restraint, a dull hardship instead of regarding it as a route to lifelong prosperity and an experience we can actively manage and enjoy. While we're considering saving, Cramer points out, it's equally important to be taking steps to avoid poverty. He singles out two key factors that can adversely affect financial health — high-interest credit card debt and lack of adequate health insurance, the top two causes of personal bankruptcy in the US. Dealing with these is a priority. Credit cards must be paid down using techniques like "snowballing" — rolling all balances into a single, lower-interest card — or borrowing from pension savings, against an insurance policy or against your home. The point is that you are unlikely to be able to achieve an investment return that beats the 20% or so interest rate credit companies charge so you can't carry a balance on your credit card while trying to build wealth. A third fundamental element of avoiding poverty so you can get on the savings ladder is to have a budget — not just for this week, this month or even this year but for the whole of your life. Six Steps to Smart Budgeting We have to recognize that, if wealth begins with saving, the richer we want to be, the less we will have to spend right now. But to manage this strategy comfortably, we need a firm understanding of our current spending and a budget structure that enables us to manage it in future. He suggests six key steps to having a smart budget: 1. Learning from the past. Review your overall spending in the past year and take a detailed look at the past three months. Calculate your total income and expenditure, noting what you have spent on essentials and what has been spent on discretionary, non-essential purchases.
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2. Judging your past. By reviewing past expenditures and looking for lowercost alternatives even for some essentials, you calculate how much less money you could spend compared with the previous year. Work out how much this would be worth invested with compounding returns of 5% (if invested in bonds and money market) and 10% (invested in stocks). 3. Creating your short term budget. Using the information you now have and removing the one-off items from last year's income and expenditures, calculate what you could save each month. Don't set too tough a goal or you won't make it. 4. Creating your long term budget. Now you build in future big-ticket items that you need to save for and create a timeline to see how long it will take (knowing your saving ability) to get what you want. 5. Holding yourself accountable. You cannot create a budget and then forget about it. You must constantly monitor actual performance against what you said you would do. At first you may find you're spending more than you planned — the aim should be to seek continuous improvement. 6. Taking drastic measures if you fail. If you can't live within your budget look for ways to get yourself in line. Consider automating your savings — a regular deduction into an account that's not easily accessible. But if you do this, destroy your credit cards too, so you won't be tempted by another source of easily available funds! Planning for Retirement Investing for retirement is your first priority, says Cramer, and thanks to the power of compounding interest, retirement fund tax incentives and, in some cases, matching retirement account contributions from employers, it's also one of the least difficult financial tasks to accomplish. Where employers do make contributions, as in the US 401(k) system, you should almost always save this way first, up to the maximum that also attracts matched contributions. You will gain substantially from both these employer payments and the deferment of income tax on your contribution. However, he warns that the 401(k) mechanism itself does not always follow the best approach to investment. First, in the most typical form 401(k) application, you are usually offered a limited number of mutual funds in which to invest and they may not be the best possible investment vehicles from which to choose. Second, whoever administers the fund will charge a sometimes hefty and often unnoticed fee. And third you may be encouraged to invest in the company that employs you — something you should never do, the author warns; your employment is already a big enough exposure to them.
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Even so, the twin benefits of matched contributions and deferred tax still make this an attractive starting point for investing for retirement. The author offers four tips to exploit a 401(k) plan: 1. Plan to contribute, each month, one twelfth of the total annual amount you can afford, (only up to the maximum allowable amount that attracts matched funding from your employer) but if the stock market falls by 10% or more, double up on your investment the next time you can contribute, so you're buying stocks when they are cheap. 2. Remember that stocks offer the best returns. Even when you near retirement and lean more towards less risky investments such as bonds, you should maintain 30% to 40% of your fund in stocks. 3. Invest in index funds that track overall market performance and charge the lowest fees. Actively managed funds fail to beat the market (and thus tracking funds) 80% to 90% of the time. 4. Only contribute the maximum amount that attracts matching funds from your employer. After that, there are better things to do with your money, such as paying into an Individual Retirement Account (IRA) or an Registered Retirement Savings Plan (RRSP) in Canada. The big advantage of IRAs (or their equivalents) — in addition to the tax incentives they offer — is that you choose where you invest from the whole market place, not just the funds that are specified inside a 401(k). And you can do so without having to pay high administrative fees. However, the amount you're allowed to invest each year is much lower than in a 401(k), though you should still aim to save your maximum entitlement. The author draws the distinction between the two main types of Investment Retirement Accounts — the regular tax-deferred version and a non-deferred account known in the US as a Roth IRA. The rule of thumb between these is that you should contribute to a Roth when you are younger and in a lower tax bracket. Then when you retire and would be in a higher bracket, your income is actually tax free. Once you have your full match in a 401(k) and maxed your IRA entitlement, your retirement is taken care of. Only then can you start to think about making yourself wealthy in the present. Investing for a Lifetime Although investing for retirement is your top priority, you also need to think about your near-term prosperity. And whether your strategy is focused on the IRA portion of your retirement portfolio or on a discretionary portfolio aimed at building nearer term wealth, you need to know what you should be investing in. "For anyone who wants to build wealth to use in that big chunk of your life that 4
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happens before you turn 59-1/2," — the age at which you can withdraw retirement funds without tax penalty — "you need to invest as much as you can in your discretionary portfolio without looting what should go to retirement funds," Cramer says. Your portfolio should comprise a mix of stocks and bonds. Whether stocks are in the form of individual company holdings or mutual funds depends on how much time you have to devote to investing but the important thing is that the balance between stocks and bonds shifts as you get older and focus more on capital preservation rather than appreciation. Bonds generally offer a lower return but less risk than stocks, so your portfolio shifts in this direction over time. The author's recommendations are as follows: Age
% in Stocks
% in Bonds
Under 30
100
0
30-40
80-90
10-20
50-60
70-80
20-30
50-60
60-70
30-40
60-retirement
50-60
40-50
Retirement
30-40
60-70
Stocks: The author admits he may have done more harm than good in the past by encouraging people to invest in individual stocks. Now he stresses that you should only invest in stocks if you are prepared to do the necessary homework to get to know a company well. By that he means reading all the company reports and listening to the conference calls many companies now offer investors online or by phone. An hour per company per week is his recommended commitment and, if you can't make that time, don't invest in individual stocks. But done properly, as the author has explained in his earlier books, it's perfectly possible to beat the market. Bonds: Bonds are tedious but they're absolutely necessary for building long term wealth, Cramer tells us. The important thing is to understand the "pecking order":
Treasuries which, to all intents and purposes, are risk free. Agency bonds issued by Government-sponsored bodies like Fannie Mae in the US — they off better returns than Treasuries but are slightly more risky. Corporate Bonds — normally held by individuals only through mutual funds, they offer varying degrees of risk and corresponding levels of return; if a company goes bust, you still have a priority call on the assets.
CDs are not bonds but are similar. They yield slightly more than Treasuries but you normally have to pay a penalty for early withdrawal. The author's verdict: Stick 5
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with Treasuries Mutual Funds: If you don't have the time or desire to invest in individual stocks, buy units in a mutual fund. Trouble is, there are numerous types and thousands of funds and you need to know what's good and what's not. Some charge exorbitant fees to get in or get out of the fund, plus management fees in the middle. The author is a strong advocate of owning index funds if you don't have time to study individual stocks. Most mutual funds have higher fees and underperform the indexes, so unless you know a good specialist fund manager to follow, you should buy an index. Anyway, in the author's opinion any fund that focuses on something as narrow as a sector or a country is a bad investment. Lessons Learned The author devotes a chapter to what he describes as New Rules for Investing. Most of these are based on hard lessons Cramer himself has learned in several decades of investing and advising. For example, he advises readers not to invest as if they were hedge fund managers, even though he achieved annual returns of 24% for his fund. What he means is: avoid short termism. The desire to get in and out of stocks and realize a gain — done in his case in order to satisfy his wealthy clients every day — can be at the expense of much greater gains that could be achieved if the stocks are held longer. On a similar theme, he advises that you shouldn't let the market shake you out of a good long-term thesis. In this case, he is thinking of his own experience with ammunition-maker Alliant Techsystems. He bought the stock against the background of war in Iraq and saw a swift surge from $67 to $75. When the stock market subsequently dipped for unrelated reasons, Cramer abandoned his strategy and sold for a quick profit. But the war went on and the stock climbed to $112. Another tip based on his own painful experience is to beware buying a low value speculative stock, as he did when he bought shares in debt laden cable TV company Charter at $4 each, believing the company was about to transform its financial position. It didn't and Cramer exited at $2, scoring the biggest ever loss for his charitable trust — more than $130,000. Some of his other tips:
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Never buy the best house in a bad neighborhood — figuratively speaking. In Cramer's case he bought stock in a highly successful radio outfit as the commercial radio market was turning down. Even though this was the best of the bunch, its stock still tanked.
Love the product, don't love the stock. Just because something impresses
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you as brilliant doesn't mean its stock will be. Cramer bought shares in software company Citric after becoming an enthusiastic user of its Go To My PC program, only to discover that he was one of the later adopters and nearly everyone who could use the software had already bought it.
You are not an index fund; you don't need to own one kind of stock. Just because a certain sector is not represented in your portfolio doesn't mean you have to be in it. It could be an unhealthy sector. And, it's perfectly possible to have a diversified portfolio without being in every sector.
Be suspicious of technical analysis; it tends to miss all of the turning points. Such analysis, which purports to show stock performance patterns than you can cash in on, is very seductive but, as Cramer discovered, waiting for a stock's performance to turn, based on these supposed patterns, can lead to missing the boat.
Pros and Amateurs A valuable insight is offered into how professional investors act can to help those Cramer terms "amateurs," to improve their performance. You can see both groups in action and, more particularly, the tremendous gulf between them on a recently established social networking site, www.stockpickr.com. For example, he notes, pros always have cash available to seize on a buying opportunity, whereas amateurs are always fully invested. And pros don't buy on upcoming quarterly results, whereas amateurs do — believing they can make a killing if they correctly guess the outturn. Professionals also try not to invest in companies they don't know, although Cramer admits to getting his fingers burned when he recommended a nanotech company that subsequently slumped 20% for reasons that he found unfathomable. A key lesson from the pros for all investors is how they behave when the market dives. Most of us, it seems, close down our screens and avert our eyes from our portfolio statements, preferring not to know the worst when the market has slumped. This is the very time we should be tuning in, to get explanations. And it is the reason why so many people lost money from peak to trough between 2000 and 2002, during the tech stock debacle. Pros never avert their eyes from a downturn. They also know that even when things are good, not everything works at once. While most of us expect to see all our stocks performing well when the market does, that is not how reality works and we should not get frustrated or take short term actions in response. Bull Markets, Stock Tips, and Mutual Funds
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In typical forthright fashion, Cramer concludes with a series of stock and mutual fund picks and a number of market predictions. As he says on his show: "There's always a bull market somewhere." The stock market universe is not a single entity moving in a single direction at a uniform speed. Although no sector remains a bull market forever, those that Cramer believes to have the best potential over the next five years are:
Aerospace and defense. Agriculture. Oil and Oil Service. Minerals and Mining. Infrastructure — for example road and bridge builders, and pipe layers.
And the individual stocks he recommends for the long term, based on factors such as company performance, share buybacks, dividend yield and price/earnings ratio, include:
Heavy industrial equipment maker Caterpillar. His previous employer, brokers and finance specialist Goldman Sachs. Oil company Conoco Phillips and drillers Transocean. Healthcare specialists Hologic, Inverness Medical Innovations and CVS Caremark. Fast-foodsters McDonald's, beverage icon Pepsi and consumer products leader Procter & Gamble. And, in technology, the likes of Hewlett Packard, Corning, Google and International Game Technology.
On mutual funds, Cramer delivers the oft-repeated warnings that you shouldn't pick mutual funds based purely on recent performance and that index funds general do better than the vast majority of managed funds. Having said that, there are some managed funds where he does see potential, especially those where he admires the fund manager. These include:
CGS Focus Fund which, among its successes, shorted stocks (i.e., sold stocks it didn't own and then bought them at a lower price) as the technology bubble burst. Buffalo Small Cap which practices a low turnover of its holdings and thus pays low capital gains tax and signals that it is a long term investor. Putnam Small Cap Value run by a manager "who can make you money when other funds can't stop losing." Heartland Value if you are looking for something with larger cap exposure than the two mentioned above.
Conclusion Cramer wrote this book to build on the investment guidance in four previous works 8
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and, since he can no longer invest for his own benefit, he can claim absolute objectivity in his advice. Indeed, he contends that his only reason for writing the book was to help make his readers richer and that, unlike other investment book advisors, he has been through the mill and knows what he is writing about from firsthand experience. To take his path to financial success remember his key points. Financial health comes first — health insurance and lack of credit card debts are a must. You must budget strictly to yield as much saving potential as possible. Your priority should be your retirement funding using tax efficient accounts. You need to be in stocks if you want to maximize your wealth potential. You should strike a balance between stock and bond ownership that reflects your age. And finally, if you don't have the time or inclination to study individual stocks or managed mutual funds, buy index funds. To your financial health!
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