Yesterday morning, I wrote a fairly controversial article where I described individual stock investing as akin to gambling for the average investor.

The impetus for that article was Jim Cramer’s appearances on CNN just before the Bear Stearns collapse, shouting loudly that Bear Stearns was in great shape. Check it out if you want to get a taste of Cramer’s demeanor and “advice” that turned out to be almost the complete opposite of reality:

Here’s the scoop in a nutshell for those of you who don’t follow such things. Jim Cramer is probably the most vocal and best known advocate of individual stock investing in the United States. Following a very successful stint as a hedge fund manager, Cramer began hosting what became the top-rated show on CNBC, entitled Mad Money, where he basically acts hyperactive, yelling and running around the set voicing his opinions on various individual stocks.

On March 11, 2008, Cramer loudly said on his show that the large investment bank Bear Stearns was in fine shape and that no one should pull their money out of the stock. Within a week, Bear Stearns was being bought out by J.P. Morgan and the stock value had dropped 90%.

When this all unfolded, my reaction was that this was evidence that individual stock picking was basically gambling. If Cramer didn’t know what was coming due to a lack of information, how would anyone else? Even more so, Cramer was adding bad information to the pool - people strictly taking Cramer’s advice would have completely tanked. As I said yesterday morning, individual stock picking is all about information and knowing how to find the right pieces to look at, and if someone who is supposedly a true authority at stock picking couldn’t see something that huge and devastating coming down the pike, an average individual investor has no chance at all.

After some more thinking, I turned the whole situation around again: what if the problem is Cramer himself?

The Cramer Effect
In stock trading, the “Cramer Effect” (or Cramer Bounce) is the positive bounce that most stocks get as soon as they’re mentioned on Cramer’s television show. Because Cramer has such a large audience, there are a lot of people who simply go out and buy a stock based on his recommendation.

However, when I look at the “Cramer Effect,” I think of it more widely. To me, Cramer’s real important effect is that he has built up a substantial interest among a casual crowd in individual stock investing. His show is exciting, loud, and colorful, and thus has attracted an audience that might have otherwise been watching SportsCenter or something like that. Instead, they’re watching Cramer, learning about individual stock investing, hearing about specific instances of incredible returns, and then getting involved themselves.

Is this a financially healthy thing for those people? I think it depends on what they take out of Cramer’s message. Let’s look at both sides of the coin.

Why The Cramer Effect Is Bad
On Mad Money, Cramer has a segment called the Lightning Round, where viewers call in, name a stock, and Cramer gives a buy, hold, or sell recommendation within a second. He does this by simply drawing a very fast conclusion about the sector that stock is in and whether that stock is the best stock in the sector. It’s not based on any sort of thorough research, yet people buy and sell in the real world based on what he says. That’s pretty scary - because someone on television mentions buying or selling a stock based on one second of off the cuff thought, people change their financial position.

The most obvious indication that this phenomenon really does exist is that “Cramer Bounce” I mentioned above - it’s observable and real. A lot of people out there are buying based on what Cramer recommends on his show, and as I said above, that’s pretty scary. Even worse, it teaches really, really poor investment discipline - someone on TV thinks about a stock for one second, makes an off-the-cuff guess, and you’re changing your investment approach? That’s not sound investing at all.

The Beauty Is In The Details
Yet I’m not quite ready to toss Cramer into the trash can. If you actually take the time to sit back and read his books - particularly Real Money, which is by far his best one - you’ll find that the message he talks about is about as far from the Lightning Round as can possibly be.

The big message that you get out of actually reading Real Money is homework, homework, homework. He flat-out says you should not own a stock if you’re not willing to do an hour a week of research on that stock: reading annual reports, listening to conference calls, watching what stock moves the insiders do, reading the news, and so on.

That’s something I can agree with and stand by. You should not own an individual stock unless you have a specific and compelling reason to own that stock. Furthermore, you need to invest the time to make sure your specific and compelling reason hasn’t gone away, which would mean it’s time to sell the stock. If you can’t invest that time, then you might as well go toss your cash on the roulette wheel.

Why Irrational Is “Cool”
So why isn’t that sensible message talked about on television? It is, on occasion - Cramer talks regularly about doing the homework. But that’s not the part of his show that seems exciting. It’s when he shouts, does something crazy, screams “Boo yah!” and such that grabs the attention, and that’s the stuff that’s directly associated with stock picks.

Just a few weeks ago, I talked in detail about Dan Ariely’s book Predictably Irrational, which focuses in on why people make irrational decisions - like, for example, basing your investment strategy on an off-the-cuff remark from a television personality.

Ariely reveals two reasons why Cramer’s seeming irrationality is followed by many people. First is the idea of relativity - they feel a need to be on the cutting edge of stock investing ideas. This is similar to why we feel some sense of jealousy and drive when our neighbors have a nice new car. This is largely the reason why people would watch CNBC and read specific stock investing advice. They feel a need to have “insider knowledge” as relative to others in their cohort - in other words, other individual stock investors, thus they follow stock tips.

The second idea is that of passion. Cramer brings more passion, energy, fire, and drive to the table than about anything else on television. It oozes out of the man - he plainly loves stock investing and that love comes out quite clearly on his show. It rubs off, and that’s how he’s attracted an audience - people like to see others with passion and they tend to believe others that show passion (think of televangelists, for instance).

Combine these two factors, plus the fact that his show has a very action-oriented sensibility, and it’s fairly easy to see why people would follow the quick pick advice and not necessarily follow the “do an hour of research per stock per week” advice.

Some Final Thoughts
Cramer’s got some good things to say if you know where to look and where to listen. The problem is that this isn’t the stuff that excites people and gets high ratings - the stuff he says that’s valuable is the boring stuff. Thus, it’s very easy to just see Cramer’s advice for the excitement, where he runs around on stage like a maniac yelling “BUY BEAR STEARNS!” even though he’s not done the research.

If you really want to get into individual stock investing, read Cramer’s books and do a lot of homework. Don’t jump on an individual stock pick just because you heard about it somewhere - do it for a compelling reason and keep your eye on it carefully to make sure that reason still exists.

And listen to Cramer, too. Listen to the part where he gives advice on how to do the homework, not the part where he yells, tosses a chair, hits a buzzer, and screams “BOO YAH!” That won’t get you very far down the road of financial success.

Having read a small mountain of personal finance and investing books in the last couple of years, I’ve come to realize that there’s some significant overlap in the ideas presented in the books. Spend less than you earn and avoid high-interest debt pop up again and again, but I wanted to look at perhaps the most powerful idea presented across a wide swath of investment books: invest your money in index funds.

I wrote out the case for index funds a while back: they’re easy and don’t require much time investment, they’re very cost efficient, and they outperform virtually all managed mutual funds. However, I wanted to point out that this argument isn’t mine and mine alone - it’s shared by a small army of people who write on investment topics. (In the quotes below, I’ve added my own emphasis.)

For starters, John Bogle, the founder of Vanguard, writes in The Little Book of Common Sense Investing (read my review of the book) on page 200:

Deep down, I remain absolutely confident that the vast majority of American families will be well served by owning their equity holdings in an all-U.S. stock-market index portfolio and holding their bonds in an all-U.S. bond-market index portfolio… The rationale for a 100-percent index fund portfolio remains as solid as a rock. It’s all about common sense.

Burton J. Malkiel, a Princeton professor and a former member of the Council of Economic Advisors, writes in A Random Walk Down Wall Street (read my review) on page 358 of the ninth edition paperback:

For many investors, especially those who prefer an easy, low-risk solution to investing, I recommend bowing to the wisdom of the market and using index funds for the entire investment portfolio. For all investors, however, I recommend that at least a portion of the investment portfolio - especially the retirement portion - be invested in index funds.

Malkiel also writes in The Random Walk Guide to Investing (read my review), paperback edition, page 136:

[Index fund investing] has outperformed all but a tiny handful of the thousands of equity mutual funds that are sold to the public. Let’s list all the advantages of an index fund strategy:
- Index funds simplify investing. You don’t have to choose among the thousands of individual stocks and mutual funds available to the public.
- Index funds are cost-efficient. [Many] have no sales charges and have miniscule expense charges. Moreover, index funds do a minimal amount of trading. Thus, they avoid the very heavy transactions costs of actively managed funds, which tend to turn over their entire portfolio about once a year.
- Index funds regularly produce higher returns for investors than do actively managed funds.
- Index funds are predictable. You know beyond doubt that you will earn the rate of return provided by the stock market. Yes, you will lose money when the market declines, but you will never own the fund that performs several times worse than the market.
- Index funds are tax-efficient. If you do own stocks in taxable accounts (that is, outside your IRA or retirement plan), then you need to invest in index funds that don’t trade from security to security and therefor don’t tend to generate taxable gains.

What about Taylor Larimore, Mel Lindauer, and Michael LeBoeuf, authors of the acclaimed Bogleheads’ Guide to Investing (read my review), on page 78 of the paperback edition?

Index funds outperform approximately 80 percent of all actively managed funds over long periods of time. They do so for one simple reason: rock-bottom costs. In a random market, we don’t know what future returns will be. However, we do know that an investor that keeps his or her costs low will earn a higher return than one who does not. That’s the indexer’s edge. More specifically, here are the cost and other advantages of indexing:

1. There are no sales commissions.
2. Operating expenses are low.
3. Many index funds are tax efficient.
4. You don’t have to hire a money manager.
5. Index funds are highly diversified and less risky.
6. It doesn’t much matter who manages the fund.
7. Style drift and tracking errors aren’t a problem.

William Bernstein, one of the nation’s top financial theorists, writes on page 98 of The Four Pillars of Investing (read my review):

Clearly, the best way to avoid [overpriced and underperforming mutual funds] is to simply keep your expenses to a minimum and buy the whole market with an index fund.

And then on page 102:

Failing to diversify properly is the equivalent of taking [your stock investment’s] uncertain return and then going to Las Vegas with it. It’s bad enough that you have to take market risk. Only a fool takes on the additional risk of doing yet more damage by failing to diversify properly with his or her nest egg. Avoid the problem - buy a well-run index fund and own the whole market.

Paul Farrell, a former Morgan Stanley investment banker and financial reporter, writes in The Lazy Person’s Guide to Investing (read my review) on page 111 of the paperback edition:

Of all the predictors, the [Financial Research Corporation] concluded that the expense ratio is the only really reliable one in predicting future performance, because funds with low operating costs “deliver above average future performance across nearly all time periods.”

Conversely, all other predictors turned out to be unreliable - including Morningstar’s famed star ratings and the highly regarded Sharpe Ratio developed by a Nobel laureate in economics.

Bottom line: if you want predictable performance, pick cheap funds. That means no-load index funds. And since Vanguard has the lowest expenses, it should come as no surprise that its funds appear over and over in the lazy portfolios developed by so many independent sources.

The Sharpe Ratio? That refers to William Sharpe, winner of the 1990 Nobel Prize in Economics and professor emeritus at Stanford. In Investors and Markets, he writes on page 146:

An index fund investor can then come very close to achieving the expected utility attainable with large amounts of expensive research and analysis… [the argument that] few of us are as smart as all of us, it is hard to identify them in advance, and they may charge more than they are worth is perhaps the most realistic argument for investing much (if not all) of one’s money in mutual funds.

Even Jim Cramer, who couldn’t possibly be a louder advocate of individual stock investing, says the following in Stay Mad For Life (read my review) on page 87:

Invest in index funds or the lowest-cost mutual funds offered by your 401(k) plan. This is the conventional wisdom on Wall Street, but it’s the advice that most people fail to take. People always want to know which mutual fund will give them the best return, but it turns out that’s a bad question. Even before you add up the fees, actively managed funds fail to beat the market 80 percent to 90 percent of the time. That means that at least in your 401(k), you’re better off investing in an index fund with low costs that simply tries to mimic the performance of the entire market than in a mutual fund that tries to beat the market.

Here’s the scoop in a nutshell, people. If you’re like me and you don’t have hours every week to study individual stocks, but you want to invest in stocks and enjoy some of the tremendous gains you can earn, there is no better option available to you than a low-cost index fund. As of this moment, every single dime (outside of my retirement plan) that I have invested in the stock market is in Vanguard index funds. I’ve watched tons of individual stocks and mutual funds and how they’ve done over the last few years and these guys are all spot on - index funds simply get the job done, easily and effectively.

If you have extra money and want to invest it in the stock market, index funds are the way to go. I got started with Vanguard and they’ve treated me exceptionally well both in investment quality and customer service - I’ve never seen any reason to go anywhere else.

A lot of people like to make fun of Jim Cramer’s antics, but I actually quite like the guy. His stock picks are generally useless (because of the “Cramer effect” of a herd of people buying them), but if you ignore that, listen carefully to his discussion of fundamentals, and let yourself be entertained a bit, he’s quite worthwhile. In fact, I found his book Real Money to be a very interesting, readable, and fundamentally sound book on individual stock investing.

This brings us to Cramer’s latest book, Stay Mad for Life. This time around, Cramer’s actually addressing general personal finance issues (for the most part) instead of focusing strictly on individual stock investing as he has in his last two investing books. The end result is a personal finance book with a mix of long term and relatively short term perspectives, particularly as compared to other books. It also has a healthy dollop of the Cramer entertainment factor, for better or worse, and there is some coverage of individual stock investing, too.

Is the advice good, or at least thought provoking? Definitely. Does it measure up to many of the best personal finance books out there? Let’s leap in and find out.

A Trip Through Stay Mad for Life

Right off the bat, in the introduction, Cramer frames this book with this interesting comment: “Too many books about money go wrong because they try to offer timeless advice. There’s no such thing as great timeless advice.” Some are going to immediately say he’s wrong, and he is to a certain degree. It is always a good idea to spend less money than you earn, for example, and it’s always a good idea to avoid high interest debt.

The catch here is that Cramer’s using a different definition of personal finance. To him (at least, as best as I can judge by this book), personal finance refers to the way that you allocate your money. You might put some in your 401(k), put some in your Roth IRA, put some in your checking account, perhaps put a little in your taxable investments, and so on. He basically assumes that the “spend less than you earn” mantra is completely common sense, and the idea that you should put money away for your future is just assumed. Thus, Cramer’s definition of personal finance is what you do next. For the most part, that’s the perspective that the entire book takes, particularly once you get past the second chapter.

Chapter 1: Getting Started
The entire first chapter of this book can be summed up in one word. Save. That’s right, Cramer’s most fundamental principle of all is the right one: spend less than you earn. Put some of your hard-earned money away so that you can live out your dreams in the future.

Sure, some wiseacre will probably show up and start mumbling about “leverage” and stuff like that, but “leverage” doesn’t mean that much if a giant tidal wave of personal destruction shows up at your house, leaving you jobless and with $150,000 in borrowed money sitting in an investment account that has just coughed up 20% in the last month.

Cramer’s pretty clear in this chapter, and I agree, so I’ll state it again: the only real way to get ahead is to spend less than you earn and do something intelligent with the cash left over.

Chapter 2: How to Stop Yourself from Becoming Poor
Cramer offers six basic steps for sound personal finance management:

Step 1: Learn from the past. Basically, this means to keep track of your spending for a period of time. Note everything that you spend for at least a month, if not three months.

Step 2: Judge the past. Take all that data and spend some time studying it. Look for things that you’re obviously spending too much on, and consider ways to reduce that load. The biggest one to look for are repetitive things and high-dollar things.

Step 3: Create your short term budget. This is basically short-term goal setting. Set some personal finance targets for reducing your spending and putting some money away into savings for the next month, next quarter, and/or next year.

Step 4: Create your long term budget. After that, identify and begin planning for any major personal finance moves that are coming in the next ten years or so. Plan ahead for that next car purchase, for that mortgage, and so on, because by planning now, you’ll save yourself some financial pain later.

Step 5: Hold yourself accountable every month. Each month, sit down and do an honest look at the numbers. Don’t flinch, and don’t skip it - without this honest look, it’s very easy to convince yourself you’re doing well.

Step 6: If you fail, take drastic measures. Basically, this means automate it if you’re not getting it done yourself. I see what Cramer’s getting at here - it’s far better to exercise your own willpower than to rely on automation - but I think automatic deductions from your checking account can be really useful.

Chapter 3: Planning for Retirement
This is one of the best summaries of retirement accounts I’ve ever read - this is probably the best chapter in the entire book. In fact, Cramer’s argument is so persuasive and well thought out that I’m going to seriously look at a minor change in how I put away money for retirement.

The usual advice for people investing for retirement is to put money in their 401(k) up to the employer match, fully fund a Roth IRA, then max out your 401(k) if you can afford it. Cramer advises a bit differently: put into your 401(k) up to the match, then max out an IRA (using a Roth IRA for some of this if you’re eligible), then invest in a taxable account. Why? The investment options on the average 401(k) are terrible - you’re far better off putting your cash into an IRA managed by Vanguard or Fidelity where they have some very efficient and strong investment options. This makes a lot of sense - I’ve fully funded a Roth IRA with Vanguard this year and am dumping as much as I can into my 401(k) plan, but I’m now thinking about just doing up to the employer match and then moving the rest of my contribution into a taxable account with Vanguard.

Another tip: if you leave your job and have a traditional 401(k), take advantage of the rollover and roll it into an IRA that you can control and that has strong investment options.

Chapter 4: Investing for a Lifetime - and What You’re Investing In
What about investing outside of a retirement account? There’s a lot of appeal to this, because you can invest for non-retirement goals as well; in fact, I’m doing this very thing. Unfortunately, this chapter really doesn’t offer anything new that isn’t found in other investment books.

Cramer offers a few basic guidelines for this type of investing, including some very simple stock vs. bond allocations, and he provides a lot of background material on different investment options. Generally, Cramer encourages people to invest in bonds via an index fund and to invest in individual stocks if you have the time and tolerance - otherwise, you should focus on stock index funds.

Chapter 5: Family Finances
This chapter is basically three short chapters rolled up into one: handling money and children, saving for college, and buying a home.

On children and money If you want to teach children about money, don’t just get them a passbook for a savings account at the local bank - it’s boring, and they won’t learn anything. Instead, try to involve them in what you do for finances and get them excited in getting ahead financially. This is much the same advice found in the excellent The First National Bank of Dad.

On saving for college Start putting money in a 529 and/or a Coverdell - and do it now. I actually started my daughter’s 529 before she was born, and my son has more put away for college right now (he’s just over two years old) than either of his parents had the day that they went off to college. Do it now - you won’t regret it.

On buying a house Save up for a down payment first and do not get a subprime mortgage unless you like watching money burn. If you need to live in cheap housing for a while until you can afford it, do it - don’t jump the gun and waste mountains of cash for the rest of your life.

Chapter 6: Twenty New Rules for Investing
At this point, the book somewhat takes a turn to being more like an update on Cramer’s earlier books. This chapter is mostly a list of the lessons Cramer has learned about investing since quitting his hedge fund and instead investing like an “ordinary investor” in his charitable trust. It’s interesting reading if you’re heavily into individual stock investing, but it feels like an abrupt change from the rest of the book.

The most interesting nugget for me from this chapter is that he repeatedly says in various ways that you don’t need to invest in anything: you don’t have to buy a certain stock to fill a hole in your portfolio, you don’t have to invest in what your friends are suggesting, and you certainly don’t have to follow the up and down vagaries of the day to day market. In other words, groupthink is pretty atrocious, and I think anyone who is involved with investing can agree with that.

Chapter 7: What the Pros Do Right and the Amateurs Do Wrong
This was an excellent chapter for anyone who is beginning to invest in individual stocks to read. What it boils down to is that amateur investors often don’t have discipline, even when they convince themselves that they do.

What does that really mean? It basically means that short term market timing doesn’t work, that investing if you aren’t already in good financial shape is stupid, and that investing in businesses you know nothing about is stupid. If you think of stock investing purely as a fun game, you will lose, because for countless people out there, stock investing is a business.

Chapter 8: Five Bull Markets and Twenty Stocks for the Long Term
It wouldn’t be a Cramer investment book without some specific individual stock picks and this one is no different. Of course, this time Cramer is definitely focusing on the long term - he suggests these picks to buy and just sit on over a long period.

The one pick I found very interesting is Sears Holdings (SHLD), a company that’s unquestionably going through some seriously hard times right now. Cramer’s faith in the company is mostly due to the person steering the ship, who Cramer professes a great deal of personal respect for.

Chapter 9: My Guide to Mutual Funds
Cramer closes the book by returning to advice more useful to a broader personal finance audience after his sojourn into individual stock picking. Here, Cramer looks specifically at mutual funds, and for the most part, he says they’re junk for the most part and that you should invest in an index fund if you’re going to go that route. I think it’s telling that someone with such an aggressive perspective feels as strongly about index funds as conservative investors do.

He does go on to pick a small handful of actively-managed mutual funds for people who insist on investing in them, but it’s pretty obvious that Cramer’s pretty strongly in the index fund camp.

Buy or Don’t Buy?

This book offers an interesting perspective on personal finance, one that’s not often seen in other books. Cramer’s perspective is that of a risk-taking investor - once he’s sure his most fundamental matters are covered, he’s quite willing to take rather large risks with his money, and he lives very much in the moment. It’s because of this philosophy (and Cramer’s personal bombast) that his show is so popular and he’s gained so much mainstream recognition.

Admittedly, Cramer’s persona is not for everyone. He’s loud, fairly abrasive, and bombastic. If you tune into his show and within one minute are quite ready to turn the channel, you probably won’t like this book, even if there’s some interesting information inside.

On the other hand, if you’re okay with Cramer himself, this book does offer some insight into personal finance management, particularly in the investment mechanisms and goals of the average investor. Cramer is a big advocate of individual stock investing (something I’m pretty wary of, being rather conservative in how I invest my money), and some of the specific advice is definitely “in the moment,” but the perspectives are interesting and sensible and Cramer’s writing style is as entertaining as always.

Is there something to learn from this book? Undoubtedly. I’d recommend everyone who can stomach Cramer’s persona read it. Should you follow it blindly? Of course not, but you should never follow any book blindly. Think with your own mind and combine this book’s teachings with others on personal finance, like Your Money or Your Life and The Boglehead’s Guide to Investing and The Total Money Makeover, and figure out which pieces ring true to you.

One of the most regular questions I get asked is how I feel about individual stock picking. Should a good investor have individual stocks as part of their portfolio and, if so, how do they fit? From my perspective, individual stock picks are fine as a small part of an overall portfolio. Here’s my reasoning behind that, as well as my strategies for using individual stock picking as a small part of a portfolio.

To explain things, let’s use my own investment portfolio as an example. My primary goal with my non-retirement investment portfolio is to buy a piece of land in the country, build a wonderful house on it, and allow a sizeable percentage of it remain forested. Where I live, in Iowa, you can find such land, particularly in the northern part of the state, at a reasonable price.

Looking at a portfolio as a whole
The first question you need to ask yourself is why do I want to invest in individual stock picking at all? Individual stock picking is an extremely high risk/high reward form of investment and it requires some research to stay up to date on it - you can’t drop in your cash, sit back, and expect to be successful at it. Thus, your investment goals must be in such a state that you’re comfortable risking a slice of your investment to chase big gains.

Does this mesh well with my goals for investing? What happens if I see a loss in my portfolio? The short answer is that the dream moves further into the future or we settle for something smaller, more likely the latter because we both want to be young enough to enjoy it when we can afford it. What happens if I hit a few home runs with my individual stock picking? We can buy sooner or buy something greater, like a horse stable. This portfolio, in other words, can actually sustain a sizeable fraction in a relatively risky investment like individual stock picking.

On the other hand, let’s look at a retirement portfolio. This portfolio can’t afford losses, as it means a lower standard of living in retirement or a later retirement date. Big gains help to a degree, but they mostly help pay for extravagances and gifts to family. Thus, a retirement portfolio shouldn’t include a risky piece like individual stock picking.

What should make up the less-risky portions of a portfolio? Broad-based low cost index funds of stocks and also some bond investments, in a nutshell. The index funds are more volatile than bonds, but have a long term positive track record that exceeds bonds. In both cases, the investment has an incredibly strong likelihood of increasing at a greater rate than inflation over the long term, whereas individual stock picks can be highly variable and can’t hold any such promise.

Individual stock picking as a piece of a larger portfolio
The first step is to determine how big of a slice of your portfolio you’re willing to contribute to individual stock picking. I am very conservative; I would be hesitant to have more than 25% of a portfolio in individual stocks no matter what unless the goal was purely wealth building and there was no direct use for the money in the long run.

Once you’ve determined how much you’re willing to invest in individual stocks, learn how they work. So far, I’ve found Jim Cramer’s Real Money to be the best guide I’ve read on individual stock investing in the modern world.

Getting started Cramer recommends having a bare minimum of 5 stocks in your portfolio and a bare minimum of $500 in each stock to start with - that’s a total of $2,500. I would recommend starting with more than that for cash, perhaps $1,000 in each stock.

What broker do I use? I’m far from an expert on various brokerages, but I will say that I have used E*Trade with some success, though their fees are a bit high (I discuss how fees work below). I have heard positive things about Scottrade and their fees seem much more reasonable ($7 per trade). Generally, the higher the cost, the more hand-holding and research tools the brokerage provides. In general, most of the major online brokers are quite reputable - do a bit of research and you’ll be fine.

How do the fees work? In a nutshell, here’s E*Trade’s fee chart; I have less than $50,000 in assets and do less than 30 trades a quarter, so the cost of any buy or any sell is $12.99. So, let’s say I had $3,000 and I wanted to buy 30 shares of a stock that’s at 100; I have to actually pay $3,012.99 to get those shares. The shares go up to 120 and I decide to sell them; I actually only get $3,587.01 from the sale. So instead of a 20% return, my actual return is 19.1%.

Ouch! How can I avoid being stung like that? There are two things you can do. First, when you select a brokerage, carefully investigate the costs - know what you’re paying for and why. Second, be careful when you make trades - active trading will eat you alive in fees unless you’re sure of what you’re doing. Time your buys so that you can minimize the fees you have to pay; for example, let’s say you want to buy $500 worth of five stocks to start with, then put in another $100 a month into each stock. That means that you’ll be dinged for five trades every single month. A better strategy would be a round robin approach - put $500 each month into one of the stocks. That way, you’ll only be dinged for one trade and after five months, you’ll have more in your portfolio than you would have otherwise.

What I’ve found is that individual stock picking can be a lot of fun, but it’s risky and challenging - bordering on too risky for my tastes.

When I picked up Cramer’s first investment book, Real Money, I fully expected it to be obnoxious and loud, like the book’s namesake. Instead, I was rewarded with a very interesting read - one that packed a lot of information for beginning individual investors into one thin volume. It was a fast and enjoyable read, too, so I was quite happy to give the book a pretty sizeable thumbs up.

Recently, though, Cramer produced a follow-up, entitled Mad Money. From the title and the cover alone, you can tell one big thing that’s changed: Cramer now has a very popular stock picking show on CNBC, and this book is pretty clearly co-branded with the show. What will that do to the content within? Will this be a valuable and interesting stock-picking book, or has Cramer sold out?

A quick glance through the chapter titles gives a very cloudy view at best. Some chapters look really promising (”Selling Stocks The Right Way,” “Ten Lessons From My Bad Calls,” and “Ten Lessons From Success: Some Buy And Sell Rules”); others look like television show brand extensions (”How And Why You Should Watch My CEO Interviews,” for one). I was rather queasy about picking this one up because of this air of television promotional material that surrounds the book, but I was still holding back a glimmer of optimism because I enjoyed his earlier investing book so much.

Three Steps To Buying A Stock

A large portion of the early part of the book centers around Cramer’s plan for how an individual small-scale investor should buy a stock. He breaks this down into three parts:

1. Know Yourself And Your Goals
What are you like, and what are your goals with investing? Are you temperamental? Are you young? Do you have a lot of discretionary money? These are vital questions you should know the answer to before you jump into individual stock investment.

Cramer says that there are four key factors in determining how and where you should invest: your age, your discretionary income, your timeframe, and your temperament. If you don’t have a firm grasp on each of these elements, what they mean, and how they relate to your investment, you need to kick back and do some serious self-evaluation before diving into individual stock investing.

Why? For starters, Jim breaks stocks down into four stock types, of which different ones are attractive to different people based on those factors: speculative stocks, value stocks, growth stocks, and steady earners. For example, steady earners are best for people with a shorter timeframe and who are risk-averse, meaning people who are looking at these stocks to earn steady money for them, while speculative stocks are for people with high risk tolerance and a lot of discretionary income that can take the potential hit from a big loss.

2. Do Your Homework
Cramer’s mantra is buy and homework, not buy and hold, and he means it. He gives a five step process for how to evaluate a stock, and he basically says you should never buy a recommended stock for at least 24 hours so you have plenty of time to do this homework. Here are the five steps:

1. How does a company make money? What is their business model? What keeps the cash rolling in the door?

2. What sector is it in, and how does it compare to the rest of the sector? Take a look at the recent performance of other stocks in the sector and see how yours holds up.

3. What does the recent performance of the stock and the company look like? Is the company in the trash can, or is it doing well?

4. What does the stock look like compared to the competition? You should use the forward P/E ratio and also the PEG for such comparisons, according to Cramer.

5. What does the company’s balance sheet, income statement, and cash flow statement look like? Are there any big red flags? There’s a wonderful ten page tutorial in here on how to read a company’s balance sheet that was one of the most useful things I took from the book.

3. Use Limit Orders And Buy Incrementally
Before anything else, Cramer basically commands people to have a reasonably diverse portfolio: no two large holdings in a single sector and also no more than 20% of your portfolio in any one stock, so that means a minimum of five stocks. He also advocates buying incrementally, meaning not buying your entire position at once. This is effectively dollar cost averaging. One more major point of advice: never use market orders, use limit orders, as they allow you to specify the price you want to buy at, not the price that the market gives you.

He also advocates doing one hour of homework a week per holding, which involves ensuring that your company’s earnings are okay, that your reason for owning the stock is still true (if you can’t flat out state in one sentence why you own a stock, you shouldn’t be in it), and that your company’s sector isn’t undergoing major change.

Other Investing Advice

Most of the latter two thirds of the book is divided pretty evenly between specific tips on individual stock investing and information related to Cramer’s television show, Mad Money. Today, we’ll focus on the tips; tomorrow, the madness.

One large section that I found particularly enlightening was Cramer’s advice on when and how to sell an individual stock. He broke this down into six distinct guidelines:

Keep your position the same size as a stock goes up. Let’s say you have 100 shares when a stock is at 60. If it goes to 100, you should sell 40 shares and have 60 shares at 100. In both cases, your position is the same ($600), but you’ve taken $400 in profit off of the table. By doing this, you protect yourself against the stock hitting its peak before you expect it.

Set a target price. Don’t keep riding a stock until it goes over the peak and crashes. Instead, set a target price at which you will sell, and when the stock reaches that price, actually sell it. This is a check against greed.

Unless you learn something new, sell it at the target price. Of course, if you do learn a new, important fact about the stock, you might want to re-set the target price, but still, if the stock hits the target and you have no reason to change the target, sell.

When you stop thinking a stock will go up (even if you haven’t hit the target yet), sell. Listen to what your heart and mind are telling you - if they’re not in agreement anymore, something’s not right (even if you don’t consciously realize it) and it’s time to get out.

If you double, sell half of your initial position. Why? You’ve taken your investment off of the table and now you’re playing with the house’s money. This is a great thing to do if you still are convinced the stock is going to grow and you want to keep riding it a bit longer, as you’ve essentially removed your investment from the equation and it’s all gravy now.

Always be eager to take profits. If you have a chance to take a profit, you should want to take it. Don’t convince yourself that there’s more all the time or else you’ll be eaten alive. Your disposition should always be to sell, not to hold or buy more.

Cramer also spends a couple chapters reviewing some of the tips from his last book and drawing a few different conclusions. For example, he now loudly says you shouldn’t invest based on borrowed convictions, meaning that following analysts blindly (including himself) is a fool’s game. He also goes into detail about doing the “right” homework - reading a message board about the Playstation 3 is not necessarily a good indicator about the health and future of Sony as a company.

The Television Show

The remainder of the book is focused on supplemental material to the television series, which felt to me like a bit of good investment advice padded with a lot of shilling for Mad Money on CNBC. Basically, Cramer spends four chapters in the book highlighting segments from the show. Here’s what I found that was actually worthwhile in those chapters.

The “Lightning Round” segment boils down to pretty much nothing but sector analysis. Cramer knows about 200 sectors in his head and he can pretty quickly match companies to sectors, so if he thinks a sector is bad, he usually says “sell,” and if he thinks a sector is hot he’ll say “buy.” If a sector is lukewarm, he’ll say “buy” on the best of breed in the sector and “sell” on everything else. This basically covers 95% of the stocks that come through on his show.

The CEO/CFO interviews are actually worthwhile. Basically, what you should look for are CEOs and CFOs that can carefully and deliberately deconstruct criticism levied at their company. If they lose patience or argue with Jim, you should be thinking “sell sell sell.”

The picks on the show have one big thing in common. Most of them are stocks that recently pulled back a bit from their 52 week high. If you know a stock that’s at a 52 week high, wait a week and if it pulls back a bit, there’s a good chance Jim will cover it.

The show only covers large and mid cap stocks. Jim legally can’t interfere with small cap stocks, for understandable market-manipulation reasons.

Sadly enough, those were the only really interesting tidbits I pulled from this portion of the book, which was a serious disappointment. I was especially bored by the chapter in which he highlights every. single. sound effect used on the show, even though he usually explains them on air.

Buy or Don’t Buy?

Before I even get started, let me make this clear: Mad Money is not a bad book. I quite enjoyed almost all of it. However, with that being said…

I do not recommend Mad Money to anyone who has not already read Real Money. To put it simply, Real Money is a solid, complete, and entertaining book about individual stock picking. This book, on the other hand, is best described as a supplement to Real Money with a few additional chapters explaining a television program.

That’s not to say I didn’t enjoy Mad Money; I certainly did enjoy reading it and I found much of the content to be both useful and entertaining. However, reading it in a vacuum without the pillars of Real Money and the television show to support it, it would not be a very strong book on its own.

If you simply must read a Jim Cramer book about individual stock picking, read Real Money first. If you want more meat after that, then pick up this one.

I originally reviewed Jim Cramer’s Mad Money in five parts, which you can find here, here, here, here, and here if you would like to read the original comments.

Jim Cramer’s Mad Money is the fifteenth of fifty-two books in The Simple Dollar’s series 52 Personal Finance Books in 52 Weeks.

This week, The Simple Dollar takes a look at the new investing book from Jim Cramer, Mad Money. This book is surprisingly different from its predecessor, Real Money, in a number of ways. I quite enjoyed the first one; will I enjoy this one, too? Let’s find out!

Before I even get started, let me make this clear: Mad Money is not a bad book. I quite enjoyed almost all of it. However, with that being said…

I do not recommend Mad Money to anyone who has not already read Real Money. To put it simply, Real Money is a solid, complete, and entertaining book about individual stock picking. This book, on the other hand, is best described as a supplement to Real Money with a few additional chapters explaining a television program.

That’s not to say I didn’t enjoy Mad Money; I certainly did enjoy reading it and I found much of the content to be both useful and entertaining. However, reading it in a vacuum without the pillars of Real Money and the television show to support it, it would not be a very strong book on its own.

If you simply must read a Jim Cramer book about individual stock picking, read Real Money first. If you want more meat after that, then pick up this one.

Jim Cramer’s Mad Money is the fifteenth of fifty-two books in The Simple Dollar’s series 52 Personal Finance Books in 52 Weeks.

This week, The Simple Dollar takes a look at the new investing book from Jim Cramer, Mad Money. This book is surprisingly different from its predecessor, Real Money, in a number of ways. I quite enjoyed the first one; will I enjoy this one, too? Let’s find out!

The remainder of the book is focused on supplemental material to the television series, which felt to me like a bit of good investment advice padded with a lot of shilling for Mad Money on CNBC. Basically, Cramer spends four chapters in the book highlighting segments from the show. Here’s what I found that was actually worthwhile in those chapters.

The “Lightning Round” segment boils down to pretty much nothing but sector analysis. Cramer knows about 200 sectors in his head and he can pretty quickly match companies to sectors, so if he thinks a sector is bad, he usually says “sell,” and if he thinks a sector is hot he’ll say “buy.” If a sector is lukewarm, he’ll say “buy” on the best of breed in the sector and “sell” on everything else. This basically covers 95% of the stocks that come through on his show.

The CEO/CFO interviews are actually worthwhile. Basically, what you should look for are CEOs and CFOs that can carefully and deliberately deconstruct criticism levied at their company. If they lose patience or argue with Jim, you should be thinking “sell sell sell.”

The picks on the show have one big thing in common. Most of them are stocks that recently pulled back a bit from their 52 week high. If you know a stock that’s at a 52 week high, wait a week and if it pulls back a bit, there’s a good chance Jim will cover it.

The show only covers large and mid cap stocks. Jim legally can’t interfere with small cap stocks, for understandable market-manipulation reasons.

Sadly enough, those were the only really interesting tidbits I pulled from this portion of the book, which was a serious disappointment. I was especially bored by the chapter in which he highlights every. single. sound effect used on the show, even though he usually explains them on air.

Tomorrow, I’ll give a final buy or don’t buy recommendation.

Jim Cramer’s Mad Money is the fifteenth of fifty-two books in The Simple Dollar’s series 52 Personal Finance Books in 52 Weeks.

This week, The Simple Dollar takes a look at the new investing book from Jim Cramer, Mad Money. This book is surprisingly different from its predecessor, Real Money, in a number of ways. I quite enjoyed the first one; will I enjoy this one, too? Let’s find out!

Most of the latter two thirds of the book is divided pretty evenly between specific tips on individual stock investing and information related to Cramer’s television show, Mad Money. Today, we’ll focus on the tips; tomorrow, the madness.

One large section that I found particularly enlightening was Cramer’s advice on when and how to sell an individual stock. He broke this down into six distinct guidelines:

Keep your position the same size as a stock goes up. Let’s say you have 100 shares when a stock is at 60. If it goes to 100, you should sell 40 shares and have 60 shares at 100. In both cases, your position is the same ($600), but you’ve taken $400 in profit off of the table. By doing this, you protect yourself against the stock hitting its peak before you expect it.

Set a target price. Don’t keep riding a stock until it goes over the peak and crashes. Instead, set a target price at which you will sell, and when the stock reaches that price, actually sell it. This is a check against greed.

Unless you learn something new, sell it at the target price. Of course, if you do learn a new, important fact about the stock, you might want to re-set the target price, but still, if the stock hits the target and you have no reason to change the target, sell.

When you stop thinking a stock will go up (even if you haven’t hit the target yet), sell. Listen to what your heart and mind are telling you - if they’re not in agreement anymore, something’s not right (even if you don’t consciously realize it) and it’s time to get out.

If you double, sell half of your initial position. Why? You’ve taken your investment off of the table and now you’re playing with the house’s money. This is a great thing to do if you still are convinced the stock is going to grow and you want to keep riding it a bit longer, as you’ve essentially removed your investment from the equation and it’s all gravy now.

Always be eager to take profits. If you have a chance to take a profit, you should want to take it. Don’t convince yourself that there’s more all the time or else you’ll be eaten alive. Your disposition should always be to sell, not to hold or buy more.

Cramer also spends a couple chapters reviewing some of the tips from his last book and drawing a few different conclusions. For example, he now loudly says you shouldn’t invest based on borrowed convictions, meaning that following analysts blindly (including himself) is a fool’s game. He also goes into detail about doing the “right” homework - reading a message board about the Playstation 3 is not necessarily a good indicator about the health and future of Sony as a company.

Tomorrow, we’ll look at some of the tips he leaves about watching his show.

Jim Cramer’s Mad Money is the fifteenth of fifty-two books in The Simple Dollar’s series 52 Personal Finance Books in 52 Weeks.