If we are going to invest our capital, we are going to subject it to risk. Without risk, there is no return—we simply get a little poorer each day as inflation, spending, and taxes eat away at our capital. In the following paragraphs I outline the major kinds of risk we will experience as we invest.
Some risks associated with investing in stocks are unavoidable, whereas others are relatively easily avoided. The risks that can be avoided do not, except in the hands of geniuses and the very lucky, reward us for taking them. On the other hand, over time we will be rewarded for taking risks that cannot be avoided, that are inherent in the activity of owning stocks, and we should be eager to accept those risks.
The main avoidable risk is individual stock risk. If our stock portfolio consists of only one stock, we might make a great deal of money on that investment and we might lose everything. But unless we are Warren Buffett, or unless we know a very great deal about the company (because, perhaps, we own or run it), our investment results are likely to be both random and completely beyond our control. We aren't rewarded for taking the risk of owning one stock any more than we are rewarded for playing roulette in Las Vegas.
The reason we aren't rewarded for this behavior is that it can easily be avoided—by buying more than one stock. Owning even a small handful of carefully selected ...