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In other words, any extra return you get from taking on more risk has to be kept in reserve, so you aren't wiped out by the inevitable losses.

That's what I think he means. To give an example of this in practice, take the investor who assembles a portfolio of junk bonds. Say the portfolio yields what the Merrill Lynch high yield corporate index yielded last Friday, 11.86%. On that same day the long bond yielded 5.38%. The 648 basis point higher junk bond yield is supposed to compensate the investor for risk. If the junk bond investor spends all the interest his portfolio generates, he's asking for trouble down the road when the defaults begin. To be on the safe side, he should spend as if his portfolio yielded 5.38% instead of 11.86%.

jkm929
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