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Jim Cramer's guide to investing: Make sure you can explain your portfolio to an actual person

Virginia Sherwood | CNBC
  • CNBC's Jim Cramer said it can be easy to get caught up in the hype of a hot stock without fully understanding what the company does and how it turns a profit.
  • The rise of the internet has made it so easy to buy stocks, Cramer said.

CNBC's Jim Cramer said to build a successful portfolio, investors must be able to understand and explain all their stock picks.

As obvious as that may sound, Cramer said it can be easy to get caught up in the hype of a hot stock without fully understanding what the company does and how it turns a profit, especially in fields such as biotech. According to him, buying a stock just because it is hot is never a good enough reason.

"You absolutely have to be able to explain your stock picks to another human being," he said. "If you can't explain it, you don't understand the story well enough to justify buying the stock in question, right?"

The rise of the internet has made it so easy to buy stocks, Cramer said. You can now buy a stock with the click of a button instead of being forced to explain your choices to a stockbroker.

"I urge you to be able to articulate a thesis for owning every stock in your portfolio," he said. "If you don't actually know what you own, believe me, you're gonna get slaughtered on the next decline, you are going to sell at the bottom. And there's always a next decline."

For example, some investors lost fortunes by investing in "garbage" SPAC deals in 2020 and 2021, Cramer said. Many used SPAC mergers to make money without having to follow strict rules and regulations that come with a regular initial public offering. The hype, Cramer said, far outweighed the legitimacy of these deals.

As hypocritical as this may sound, he also insisted that investors never trust everything they hear on television or read online. According to Cramer, it pays to be a skeptic, as it's too easy for money managers or individuals that like to spread falsehoods on Twitter or even on TV. It's one of the reasons, he said, that "Mad Money" primarily interviews CEOs, as it's much harder for one of them to blatantly lie about their company.

"Always be able to explain your stock picks to another human being," Cramer said. "And never take anything on faith in this business, not gospel, not from the Wall Street promotion machine and especially not from money managers who love to come on TV and tell you they are right 100% of the time."

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