The vast majority of what you read and hear about investing focuses on returns. As in, what mutual fund, or stock, or asset class investors ought to buy now to garner the best return for some indeterminate period. Or which stock or mutual fund had the best or worst returns for a given quarter or year or decade.

Risk—the flip side of reward—tends to get much less attention, except in the wake of severe market slides such as we’ve seen recently. And that’s not sensible, because risks are always present in investing (well, in life, too, of course), even if those risks are not apparent.

Few have done more than Peter L. Bernstein to help investors understand risk and appreciate the importance it holds—along with returns and costs—in building a portfolio, whether that portfolio is the retirement nest egg of an individual or a big pool of capital like that of a college endowment fund.

Mr. Bernstein, who died at age 90 this month in his native New York City, will be very much missed for his ability to explain investment theory and how these ideas developed and influence our financial markets. He had careers both as an investment practitioner—managing money for institutional clients—and as a scholar and economic historian.

He was founding editor of the “Journal of Portfolio Management,” and author of several books, including “Against the Gods: The Remarkable Story of Risk,” “Capital Ideas: The Improbable Origins of Modern Wall Street,” and a follow-up book published two years ago, “Capital Ideas Evolving,” which explained how investors applying academic theories to investing had created new opportunities and new risks. Some of the risks he warned about have very much come to the fore since he wrote the book.

We were privileged to twice feature interviews with Mr. Bernstein in our newsletter, In The Vanguard—first in January 1996, and again in July 2007. In the latter interview, conducted at a time of low interest rates, a fast-growing economy, and a booming market for stocks, he had risk on his mind.

“The curious thing is that, if you look around the world today, investing conditions are really very good,” he said. “But you just have to tell yourself it won’t necessarily stay that way.”

The consequences of risk

He went on to note that the consequences of risk were important to consider, noting that many young investors (those in their 20s and 30s) typically don’t take enough risk with long-term investments, while older investors often are overly aggressive.

“By the time you’re into your 50s and 60s, the consequences of loss are very serious, because you don’t have time to make it back,” he said. “So you have to start being more conservative.”

He cautioned that “the pace of financial innovation has gotten so rapid and so complex that, if you’re on the front line, you’re better off staying away from innovations.” He said he followed that advice in his own portfolio: If I don’t have time to know it thoroughly, I’m not going to touch it.

“Stick to those things you know,” he advised.

Balance and diversification

We asked Mr. Bernstein what investors need to understand about risk.

“The importance of being balanced across asset classes and diversified within them,” he shot back. “Many years ago an associate said to me [that] you’re not really diversified unless you own something you’re uncomfortable with. It was a wise statement. Because if you’re comfortable with all your holdings, they probably have the same flavor and are going to respond to the same set of forces.

“To be diversified, which means that returns on your assets don’t move up and down together, you have to think very hard. Today, if you own stocks of various countries, particularly American and European stocks, you’re diversified in terms of currency exposure but you’re really buying the same merchandise. They’ll tend to go up and down together.

“The main point is to avoid being wiped out if something happens to your main asset holdings.”

Challenging conventional wisdom

In the 1996 interview, Mr. Bernstein challenged the commonly held view that over the long run (even 20 or 25 years) stocks are not risky. “That’s too much a genuflection to the past,” he said, suggesting that bonds should be a significant portion of portfolios. “Bonds are the insurance policy that keeps you from selling equities when they’re down.”

Though he cautioned investors to be cognizant of the risks of stocks, he said he would never advise “staying out of stocks.”

“The fish that won’t bite at a piece of bait because he’s afraid there’s a fishhook in it is going to starve to death. You’ll go broke if you’re too risk-averse and never take any risk. You have to spread the risks a bit, and don’t panic when the risks appear.”

Notes:

• Mr. Bernstein’s opinions are not necessarily those of Vanguard.

We invite your comments on this Vanguard Blog entry. Comments will be monitored and published at Vanguard’s discretion. Comments received prior to July 7, 2009 will not be published.