Jim Cramer's Approach: How Much Fun?

Sounds to me like a lot of work

By Kaye A. Thomas
Posted August 23, 2008
Updated August 24, 2008

He advocates speculative investing and lots of homework.

Lately I've been reading Jim Cramer's Real Money, a book by the host of CNBC's Mad Money television show. As you know if you've tuned in, Cramer is the Gallagher of TV stock market pundits, making his point with all the subtlety of a sledgehammer smashing a watermelon.

I wasn't really interested in pursuing his approach to investing, chiefly because I'm not convinced it would beat the market by a wide enough margin to cover its expenses and justify its risks. Cramer's a smart guy, though (we know this because he went to Harvard Law School, and only smart people go there) so I wanted to see what he had to say in this book. As I got into it, I realized I wouldn't want to follow his approach even I had complete faith that it would work. Here's why.

Cramer's cautions

Despite his bombastic persona and his advocacy of speculative trading, Cramer isn't wildly irresponsible. He offers some important cautions to his readers. Even his critics would agree these are sound points.

One is the need to manage risk through an asset allocation that reflects how close you are to retirement. In keeping with the conventional wisdom, he says an increasing part of your wealth should be invested conservatively as you grow older. The book is mainly about how to get the best return from what he calls the discretionary part of your wealth, but that's only a fraction of your overall wealth.

Second, he emphasizes the need for diversification, "the only free lunch in this whole gosh-darned business." For good diversification you would ideally have as many as ten stocks in your discretionary portfolio, but he allows five as the minimum.

And third, Cramer insists on what he calls homework. You need to do your own work, and a lot of it. He says you should plan on spending at least one hour per week for each of the stocks in your discretionary portfolio. "You have to read every report, from the quarterlies to the annuals, you have to read every important article, you have to listen to all of the conference calls, and you have to read the analysts' reports. That's the basic homework you have to do." This kind of time commitment isn't a requirement for successful investing in general, but it's a necessary part of Cramer's approach.

Do the math

While reading this book I can't help daydreaming about how a boost in my investment return might lead to a more comfortable retirement. The trouble is that it's way too much work for the money.

Suppose I decide the discretionary part of my portfolio is $50,000. Many of Cramer's readers have less than this amount. He sets the minimum amount to get started at $2,500, so $50,000 seems like a pretty generous number.

Let's also be generous in assuming for the sake of argument that after expenses, his approach will beat the market by five percentage points per year. I want to emphasize this is part of a daydreaming exercise, not necessarily a reasonable expectation.

And here's the problem. He says I need at least five stocks, and at least an hour per week of homework for each stock. That means I spend 250 hours on this activity over the course of a year. My generous assumption of getting an added 5% return on a $50,000 discretionary portfolio, when I could have achieved a market return from an index fund with no work at all, would give me $2,500 of added wealth for my effort. That's just $10 per hour.

You can do better on an hourly basis if you're working with more than $50,000. Remember, though, Cramer says older people (who are more likely to have accumulated that kind of money) should devote only part of their wealth to a discretionary portfolio. You can also do better if you violate Cramer's other rules, investing in fewer than five stocks or spending less than an hour per week on each stock. I suspect Cramer himself would say that's an invitation to a train wreck. Cue sound effect!

Keep in mind that the assumption you'll beat the market by five percentage points is beyond generous. Someone able to achieve this result reliably would be the Michael Phelps of investing. Plenty of people do that well or better for a period of a time, sometimes extending several years, but nearly all succumb before long to the cruelty of the law of averages.

Is it fun?

This is not to say no one should try to follow Cramer's methods. Some people enjoy doing the things he calls homework. If your idea of fun includes reading a company's quarterly reports or listening in on an hour and a half conference call, you can count yourself ahead of the game even if you don't produce market-beating results.

To me that seems like a lot of drudgery, though. The same amount of effort devoted to more conventional and less risky ways of making money would add more to my wealth than I could reasonably expect from following Cramer's approach to investing. Which is a shame, because before the daydream ended I had already started spending the money.

Cramer responds

Jim Cramer responded graciously to this piece with a personal note to me, which reads in part:

There have been a lot of unfounded attacks on what I am trying to do and trying to say, it is nice to see a reasoned piece on what I am up to with lots of good cautionary and intelligent advice. Thank you very much.

He also indicated his latest book was "the one I should have written first" as it addresses the needs of people who lack the desire to do the kind of work described in the book discussed here. I have Stay Mad for Life on order and will post a review when I get a chance.