Jim Cramer: Don’t get mad, get ‘Back to Even’

In his new book, "Getting Back to Even," Jim Cramer, with "Mad Money" head writer Cliff Mason, offers a wholly new, even radical approach to investing in the new postapocalyptic financial climate. An excerpt.

From chapter one
Everyone remembers that famous quotation from Franklin Roosevelt's first inaugural address, "the only thing we have to fear is fear itself," but you hardly ever hear the rest of that sentence, the most important part, expanding on this fear: "nameless, unreasoning, unjustified terror, which paralyzes needed efforts to convert retreat into advance." Now, obviously, if you've just had your retirement fund shredded or are in danger of losing your house, you have more to fear than fear itself. Fear is a great motivator but not when it paralyzes needed efforts to convert retreat into advance. We've been through nasty recessions before, and believe it or not, it's possible to overcome the problems they create for you personally, and even to profit from the broader crisis and come out wealthier than ever. But to do that, you have to recognize that in extraordinarily difficult times, the stock market doesn't always operate according to ordinary rules. However, there are new rules, and rules I have pioneered to help you navigate your way through these brutal times. I can teach you how to learn from and play by these new rules and win while everyone else is trying to show you how to avoid a crash that already happened.

Why should you listen to me, and what makes this book so different from the standard fare? I'm a stock guy after all, and aren't stocks what got us into this mess in the first place? Look, I have been at this for thirty years. Unlike the usual peddlers of financial advice, I actually made myself rich by investing in the stock market and managing the money of my wealthy clients at my old hedge fund, Cramer Berkowitz & Company, including cleaning up during the devastating crash of 2000, when my fund was up 36 percent, while the Dow Jones Industrial Average took a 6.18 percent hit, the S&P 500 fell by 9.1 percent, and the NASDAQ plummeted 39.29 percent. I know how to make money in bear markets and during recessions. But beyond that, I've also been where you are right now. I know what it's like to lose a vast amount of money in a short period of time. I know how it feels to have my very future on the line. I understand the stress and the fear, but I also understand how to come back.

I still keep a memento of one of the lowest points in my life tucked into my wallet, and carry it with me wherever I go. It's a little piece of paper, a cutout from my daily portfolio run on the single worst day my hedge fund ever had, October 8, 1998, a date that, at least for me, will live in infamy. With less than three months left until the end of the year, my hedge fund, which was supposed to be managing $281 million, at the time was down $90,915,674 or 32 percent, because I'd made a series of boneheaded bets in the market. That's the kind of loss that would destroy most hedge funds, like the hundreds of funds that were brought low by 2008. It wasn't just my money that was at risk, it was my job and my entire career, too, not to mention my reputation, as virtually everyone I knew had written me off as a failure. Even The New York Times had written my premature financial obituary.

Video: Making your retirement money work I was in the very same position that most of you are probably in right now. My investments had cratered and my future was in jeopardy. Practically everyone around me urged me to quit and head for the hills, wherever the hills might be, since I live in a Jersey suburb of New York City. So you see, I know exactly how you feel. But I'm not telling you this to show that I feel your pain. Empathy is great, but it won't make you money. You need concrete solutions and this book is filled with them.

Between October 8, that dark day when I was down almost $91 million, and the end of the year, I did what I'm going to teach you to do in this book. I got back to even, and actually finished the year with a small profit of 2 percent. I buckled down and in less than three months I made back $110 million, averaging $1.4 million in profits every single day. Not only is it possible to come back from devastating losses, but also, if you're lucky, you can even do it quickly. Now, in one respect you're in a much better position than I was in 1998: you don't have to worry about arbitrary time constraints the way a hedge fund manager does. No clients are trying to pull out money while you try to rebuild your capital, nor is anyone even looking over your shoulder, forcing you to get back to even by the end of the year. You can afford to be patient. Of course some of you have less time than others. If you're on the verge of retirement or you're about to send a child off to an expensive college that you're paying for, then you can't be as patient as someone who's in their twenties with no dependents and no big, unavoidable expenditures on the horizon. But you still have a heck of a lot longer than I did at the end of 1998, and that makes things easier.

On the other hand, I also recognize that this is not 1998. The rules of the game have changed, and it's become harder to make money in the market. Not everything that used to work for me when I was running my hedge fund still works today. Many money managers have given up and returned to other professions, too baffled or fed up with a stock market they perceive as intractable or inscrutable at best, and downright malevolent at its worst. Ideas that were common sense or conventional wisdom even just a year and a half ago can now seem downright insane. I have always believed that putting part of your income in stocks is the best way to augment your paycheck every month, that anyone can make themselves rich by investing wisely. I still think that's true, but we also have to come to terms with some harsh new realities.

First and foremost is the fact that for many people the stock market feels broken, a totally justifiable attitude. The market has taken on a level of risk that makes it a much more dangerous place to keep any money that you think you'll need to make a major purchase any time in the next few years. And beyond that, many of you probably feel betrayed by stocks. I don't blame you! Instead of being a time-tested vehicle for wealth creation, stocks have come to be viewed as the reason why people are forced to postpone retirement or take on a second job. Stocks that were once considered "blue-chip" investments, household names that lots and lots of people owned, such as General Motors, Bear Stearns, Lehman Brothers, Citigroup, AIG, and Kodak, just to name a handful, have been bent, spindled, mutilated, and then mutilated some more. This is not like the aftermath of the dot-com bubble, where the stocks that lost people money could all be written off as overvalued, overhyped, speculative junk. These were considered real companies, revered time-tested institutions, part of the bedrock of the market — and if you owned them you got killed.

So why should you believe that investing in stocks, which got us into the mess we're in, can also get us out of it? Why not just cut your losses and stick your money in a traditional savings account where you won't have to worry about it? First of all, because you'll never get back to even that way, and second, because there is a world of difference between owning stocks, which has caused so much wealth to disappear, and trying to make money in stocks, an approach that at the very least lets you sidestep some of the pain. You can get back to even if you follow the latter course. Most peddlers of financial advice, even after the wealth-shattering crash of 2008, preach the virtues of owning stocks just for the sake of owning them. They will still tell you to buy and hold, an investing shibboleth that I have been trying to smash for ages. The buy-and-hold strategy, if you can even call it one, is to pick a bunch of good-looking blue-chip companies, buy their stocks, and hang on to them till kingdom come. Selling is strictly forbidden. It's considered a sign of recklessness, of "trading," which all too many supposed experts think of as a dirty word. Same goes for the once-sacred mutual funds, with managers who adopted the same careless buy-and-hold, one-decision philosophy.

If you had practiced buy and hold over the last decade, you would have gotten exactly nowhere. The major averages have literally fallen back to levels they first hit ten years ago. That means, for example, that if you'd contributed a little bit to your 401(k) each month, the way most people do, then most of your buying was at much higher prices. The results are in and this philosophy has lost more people more money than anything save gambling, and frankly, it's hard for me to see the difference between gambling and deciding to permanently own stock in a company that could change its stripes at any moment. It's investing blind, and investing blind is no different from investing dumb.

That's why my philosophy is "buy and homework." For every stock you own, you must spend at least an hour a week checking up on the underlying company, and that's in addition to the research you ought to do before buying a new stock. I know it sounds daunting, but I'm talking about a block of time that's shorter than an NFL or an NBA game, and certainly shorter than just about every Major League Baseball contest, even without the commercials. It's less time than you'd spend seeing a movie, and I know you've never made a dime going to the movie theater, especially not with the way they rob you at the concession stand. The homework, like taking your car in for an occasional maintenance inspection, lets you know if everything is still working under the hood, or if it's time to sell and trade the stock in for a different model. Doing the homework lets you avoid holding on to the stock of a troubled company as it meanders closer to zero like AIG and GM, or sinks all the way down like Lehman Brothers or Fannie Mae and Freddie Mac. It lets you stay on top of what's blue chip and what's been downgraded to red or white or no chip at all.

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Just owning stocks because that's what you're supposed to do won't help get you back to even. But doing the homework, and owning stocks not for their own sake but for the sake of making money, definitely can. How important is the distinction between buy and hold and buy and homework? It's the difference between passively accepting whatever hand the market deals you and taking control of your own destiny.

Let me give you an example. On my television show, Mad Money, where I teach viewers how to be better investors, help make sense of the market, and tell you which stocks I would buy and sell, I made a call, based on my homework, back on September 19, 2008, recommending that people sell at least 20 percent of their portfolio because I expected the market to go lower. On that day the Dow Jones Industrial Average had closed at 11,388.

Video: Cramer: Stock market too risky Then, a little more than two weeks later, on Monday, October 6, with the Dow a thousand points lower at 10,332, I went on NBC's Today show, and in a much-derided appearance told viewers to take any money they thought they'd need over the next five years out of the stock market because I believed it had become too dangerous and too risky. That call earned me more scorn and criticism than anything else I had ever said in a career that's been full of scorn and criticism. It was also one of the best calls I've ever made, as the market went on to have its worst week in history. You avoided a 33.6 percent decline in just two months if you heeded my first clarion call, and a 26.8 percent decline with the second. A simple sidestep into cash would have kept your savings from disappearing and thus keeping you from having to work for many more years than you had probably thought would be necessary just a few weeks before these calls were made. And I helped you get back in at the lows in many stocks using the methods detailed here, methods you can use without me after I teach you their rudiments, which will allow you to rebuild your savings and make even more money. Basically, I hit the investing equivalent of a grand slam.

Now that the market's bounced back, there are those who say my philosophy of dodging the declines is flawed versus a buy-and-forget-'em method. But these uninformed critics are ignoring the colossal difference between a rally that makes up some of your losses and a rally that actually makes you money because you sidestepped the losses in the first place. In doubt? Consider the difference between someone who avoided the decline starting September 19, my first sell call, and then got in on March 9 when I said the worst of the downside was over and it was time to come back in, versus the buy-and-hold method. The buy-and-hold philosopher with $100 in the market who ignored my September 19, 2008, sell call saw his portfolio drop to $57.50 on March 9. If he then caught the 40 percent gain through the end of July 2009, he would have $81.

Now compare the person who listened on September 19 and sold his $100 and then got back in on March 9, when I said the coast was clear. By sidestepping the loss and then getting in near the bottom he would have been able to make $40 on that $100 and would finish his round-trip at $140. The person who actively managed his money and avoided the worst part of the crash by selling on September 19 has 72.8 percent more money than the buy and holder at the end of July.

How about the October 6 sell call? The buy and holder who slept through the call saw his $100 turn to $63.50 on March 9 but would be back to $88.90 at the end of July. The person who sidestepped and got back in on my suggestion would have that $140, or 57 percent more than the buy and holder. And all of this arithmetic presumes that you didn't panic out at or near the bottom when the declines became too painful to endure. How can anyone in his right mind compare the returns and say that buy and hold makes more sense?

But in print and on television I was taken to task for being reckless and irresponsible and for causing a panic with these calls. Allegedly cooler heads responded that it would be more prudent to stay the course. But nobody said I got it wrong. They didn't care. These people thought it was more important that you own stocks than that you make money in them. The whole industry is biased toward keeping you in at all times, rather than preserving your capital so it can live and appreciate another day. Your broker, your financial advisor, they want to prevent your account from going to cash at any costs. I was a broker once and I know that the instructions were "keep people in," because brokers get paid on commission, and they will never make any money if people decide to leave the party. When you sell, they will keep calling you about new opportunities so they do not lose your money to the sidelines. And the mutual fund managers are even worse. They are totally fee based. They don't earn a fee for making you money, they just take a cut of everything that's invested with them, whether they make money or lose it. Buy and hold is perfect for them because it keeps your money in their funds, generating profits for them, even if it creates losses for you. When you retreat to the sidelines and put your money in a savings account, the whole brokerage and mutual fund industries get crushed.

Excerpted from "Getting Back to Even" by Jim Cramer. Copyright (c) 2009, reprinted with permission from Simon and Schuster.