James d. Gwartney

ELEMENT 4.8
Don’t put all your eggs in one basket.

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ownership of a small number of corporate stocks (or even worse, a single stock), you are
especially vulnerable.
You can reduce your risk through diversification
(?)
—holding a large number of
unrelated assets. Diversification puts the law of large numbers to work for you. While some of
the investments in a diversified portfolio
(?)
 will do poorly, others will do extremely well. The
performance of the latter will offset that of the former, and the rate of return will converge
toward the average.
For those seeking to build wealth without having to become involved in day-to-day
business decision-making, the stock market can provide attractive returns. It has done so
historically. During the last two centuries, corporate stocks yielded a real rate of return (real
means adjusted for inflation) of approximately 7 percent per year, compared to a real rate of
return between 2 and 3 percent for bonds.
(109)
The risk with stocks is that no one can ever be sure what they will be worth at any
specified time in the future; inevitably there will be periods over which the market value of
your investments is falling, only to rise months or years later. That risk, known as volatility, is
a big reason why stocks yield a significantly higher rate of return than saving accounts, money
market certificates
(?)
, and short-term government bonds
(?)
, all of which guarantee you a
given amount in the future. Since most people value the additional certainty in the yields that
bonds and savings accounts provide over stocks, the average return on stocks has to be higher
to attract investors away from their less risky counterparts with more predictable returns.