The Risk/Reward Tug of War

Cramer examines what risk means these days.
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A lot of the newer investors, those just getting into the game, seem genuinely mystified by those whole bond-stock thing. The collective "so what" is so powerful that I have to continue to plumb my own depths about why bonds do matter.

Bona fide old-timers are trapped in a puzzle involving risk. We are looking for investments that produce the higher return with the least amount of risk. The reason why we care about the 30-year U.S. government bond is because it is "risk-free" because it is backed by the full faith and credit of the U.S. government. That means you get the interest AND YOUR MONEY BACK.

Stocks, on the other hand, aren't backed by jack. You can lose the whole shootin' match with equities, so they are the height of risk. For many people who have invested for longer than the last five years, the tug of war is the risk/reward between stocks and bonds. If risk-free money pays you, say, 8% and the stock market pays you, say, nothing because it isn't doing anything as it is this year, which would you rather have? Of course, you would prefer to earn 8% risk-free than earning nothing with an awesome amount of risk.

Now, let's toss everything out that we know. Let's become ahistorical. Let's decide that history began five years ago and that in history the total return of the

S&P

compounds at 23% annually, risk-free. And let's make the comparisons really easy/odious, and say that there is another class of stock that can give you a 1000% return on your investment, with a little more risk.

Then, let's take the Jim Grant/Jimmy Rogers school of thought and say that the U.S. government can't pay its own debts and that the 6% offered by the government is positively risky! Full faith and credit of the U.S government printing office. That's like the full faith and credit of the Weimar Republic to some of these naysayers.

People who subscribe to this school of thought must have a hearty laugh at the notion that 5.65% on some risky piece of garbage is competitive to

Dell

(DELL) - Get Report

, let alone

Yahoo!

(YHOO)

. Even after these stocks have been clocked.

Now let's add still one more parameter. Let's say you regard investing in the Net as if it were a lottery ticket, as

Fed

Chairman

Alan Greenspan

recently suggested. What's the risk/reward of a lottery ticket? No risk; massive reward.

So, we have an investment firmament where on the one hand the piece of paper known as risk-free represents maximum risk and minimum reward, and the piece of paper known as totally risky,

nationalgiftwrap.com

, represents no risk and maximum reward.

The result? Why, that's the market we have now. No wonder people think I am a fuddy-duddy to be talking about bonds. In this traced-out world view, I am!

Random musings:

OK, now let's explain away

Micron Electronics

(MUEI)

as a problem specific to Micron Electronics. And

Compaq

(CPQ)

as a problem specific to Compaq. And

Intel

(INTC) - Get Report

as a problem specific to Intel. And the drive stocks as a problem specific to the drive stocks. What do we get? A buoyant, fabulous growth industry with a bunch of really poor executers duking it out? I don't think so.

James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At the time of publication, the fund was long Yahoo!, although positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column by sending an email to letters@thestreet.com.