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Cramer's 'Mad Money' Recap: Using the Right Investment Tools

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This program last aired on Oct. 19.

NEW YORK ( TheStreet) -- Jim Cramer opened his investing toolbox to help make his "Mad Money" viewers become better investors.

He said a good investor knows to expect the unexpected, which is why diversification is still the only way to invest.

Cramer start off with a lesson in humility -- he admitted that sometimes he gets it wrong. Sometimes his stock picks just simply don't work out. That's investing. Any investor putting together an investing portfolio needs to be prepared, said Cramer, because sooner or later something won't work out.

But how should investors prepare for the next market catastrophe or stock pick gone bad? Cramer said not by being bearish, but by being smart.

Being a bear, he continued, means shorting stocks hoping they go down. While that's a valid investing strategy, it limits one's profit potential since the lowest a stock can go is zero.

But compare that to bullish investing, betting that stocks go higher. Their potential profits are limitless, he said. Investors who invested in Apple(AAPL) in 2009, for example, realized a 580% gain over the next three years.

Beyond having a positive outlook, Cramer said the most important rule to managing your money is diversification. He said that means not having all your eggs in one sector basket. A portfolio with five stocks must have only one technology company, one health-care name, one energy company, one industrial, etc. Two or three of a kind is a quick way to get caught off guard, so no more than 20% of a portfolio can be in a single sector.

Being diversified is more than just investing in different sectors, however. Cramer said the new rules of diversification also require owning some gold in your portfolio, along with a high-yielding dividend stock, as well as a growth stock, a speculative stock and one that's firmly rooted in a healthy geography.

Check the Dividends

Cramer said the most important category of stocks that must be in a diversified portfolio is a high-yielding dividend stock. He said that every portfolio needs at least one, possibly more, dividend payers.

While dividend stocks might not seem sexy, Cramer said that, put simply, dividends make money. In fact, nearly 40% of the total gains from the S&P 500 since 1926 have come in the form of dividends. Over the past decade, that percentage is even higher.

Dividends aren't merely safety plays for retirees and cautious investors, said Cramer. They are a smart strategy for making money. He explained that as a stock price falls, its dividend yield increases, which in turn makes in more attractive to investors. Stocks that hit a 4% yield represent terrific long-term bargains, he noted, which is why stocks typically stop going down once they hit 4%.

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