Risk Versus Reward

In all investing situations, we will be confronted with both risk and reward. I cannot think of any investments that offer no risk with big reward. The most common investment opportunity I have seen is low risk - low reward, low risk- high reward, big risk - big reward, big risk - low reward.

Big risk - low reward opportunities are everywhere. Buying a stock at any price will constitute a big risk - low reward investment opportunities. The odd is even worse than gambling where the house has a 55-60% chance of winning.

You might be wondering how you can quantify risk. Reward is easier to quantify. If you buy stock A at X price and it has risen to Y, then your reward is the difference between your selling price and purchase price. Some risk can be quantify while others aren't.

Let's use an example for clarification purpose. What is the risk of buying Merck Co & Inc. (MRK)? The risk is well publicized. Investors' risk would be the potential Vioxx liability that stems from lawsuits. How much does MRK has to pay? Nobody knows for sure. We can only estimate. Some says $ 5 Billion. Another says $ 50 Billion. This is uncertainty and this is risk. You can reduce this risk by reading more and then make a conservative estimate regarding this issue.

Are there other risks associated with Merck? Sure. Patent expiration is one. Its best selling drug, Zocor, is slated to lose patent protection in 2006. Nobody knows what other drugs can replace Zocor's revenue. Competition is also one form of risk. Competitors can always outsmart a company and make a product obsolete. These are all uncertainties. These are risks. Since the future is always uncertain, the risk is always there. What we can do as investors is merely to reduce the risk by making better estimation and knowing as much as you can.