Are You Getting Paid for Risk?

You can't talk about investing without talking about risk.

This somewhat fuzzy concept incorporates ideas as diverse as the odds that you may lose money, the chance that you might underperform the market, and the notion that extreme volatility may lead to sleepless nights and a nervous stomach.

Even if nobody can manage to define risk satisfactorily, it still lurks somewhere in the back of every investor's mind. In fact, a lot of how we invest is based upon how we define and perceive risk.

Some investors are driven by the fear that they're going to miss out on "the next Microsoft," so they look to unproven and exceptionally volatile small-cap stocks in businesses like fuel cells or nanotech. Other investors are all but paralyzed by the fear of losing money, and so they stick to the stocks of stodgy but seemingly safe companies that pay dividends.

The key question in all of this, though, is whether or not you're getting paid for taking on the real risks that go with your investment. For example, both Express Scripts (NASDAQ:ESRX) and Apple Computer (NASDAQ:AAPL) have more than doubled in the past year. Both are solid, profitable companies, and I'm pretty confident that both will still be around (or be acquired) in 10 years' time.

On the other end of the spectrum, you have companies such as Capstone Turbine (NASDAQ:CPST) and DayStarTechnologies (NASDAQ:DSTI) that make no money at all today and may or may not survive to post a profit. Granted, you also have nice, "safe" stocks such as Verizon and Fannie Mae that have done a whole lot of nothing for their investors. The point is, then, that not only can you go overboard on risky businesses, but you can also lose money by misperceiving so-called "safe" stocks as more promising than they actually are.

I always make a place for what I call "spicy meatballs" in my portfolio, and I wouldn't have it any other way. Simply put, trying to find the next big story is fun, and it's a part of what makes investing exciting and interesting for me. But as time goes on, I'm struck by just how much money I can make from investing in higher-quality companies that the market has temporarily mispriced.

In other words, you can endure the spills and chills of stocks such as Overstock.com (NASDAQ:OSTK) and Altair Nanotechologies (NASDAQ:ALTI), or you can buy solid ideas such as Goldman Sachs, United Health, or TevaPharmaceuticals (NASDAQ:TEVA). The choice is, of course, yours, and there's absolutely nothing wrong with putting risky stocks (however you perceive the concept of risk) in your portfolio. Just make sure those stocks are pulling their weight and compensating you for the risks you're really taking.

For more Foolish self-help, take control of your finances by clicking here:

• Insane Investing
• 12 Ideas for Next Year and Beyond
• You Already Own Your Best Idea

Microsoft and Fannie Mae are Motley Fool Inside Value recommendations. Overstock.com is a Motley Fool Rule Breakers recommendation. United Health is a Motley Fool Stock Advisor recommendation. Check out a free trial to our newsletters.

Fools, now is the time to open your hearts and wallets to worthy causes! Please support our five Foolish charities at www.foolanthropy.com.

Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).