A Random Walk Down Wall Street

A primary focus of Malkiel’s advice centers on balancing risk and reward as an investor. Generally, Malkiel agrees with the common perception that increased risk results in increased reward, but this “reward” is better phrased as “returns,” which can be either positive or negative. Essentially, a highly volatile stock, which could be a stock with a high beta, has the potential to yield massive positive returns or massive negative returns. Even a loss of 50% would be considered a large return, in the sense that it is a large negative value resulting from what was likely a risky stock. However, quality can also function in a similar way to risk, and Malkiel notes: “The more respectable a stock is—that is, the less risk it has—the higher its quality” (131), which, in turn, “are said to deserve a quality premium,” much as risky stocks have a risk premium. However, with the advent of beta and the removal of unsystematic risk from this equation, higher risk does not always mean higher reward, though Malkiel comments that higher risk is needed to achieve extraordinary returns.

Malkiel describes a “speculator” as someone who “buys stocks hoping for short-term gain,” while an “investor” is someone who “buys stocks likely to produce a dependable future stream of cash returns and capital gains over years and decades” (36).