What happens to Bilbo Baggins in The Hobbit is that his reality is expanded. He is a silly, complacent, prosperous and unadventurous hobbit at the start. Then he goes on a journey where the perils increase, and he grows along with them till at the last he converses with dragons, experiences bitter personal rejection, lives through a great battle and has, in short, his perception of reality radically expanded. He knows more of malice, treachery and avarice as well as of goodness, loyalty and generosity than he had before. The polarities of good and evil he experiences are moved farther apart than ever they were in the Shire. An what is the result of this upon his character? He grows to a size proportionate with that reality.
That is one of the things we learn from The Hobbit, and one of the things we love it for: the splendors made available by the greater dimensions (elves and dragons and wizards). We are then perhaps ambitious to dare perils, but there is more: we desire to inhabit such a splendid world and this desire nourishes the soul so that it can grow to truly human proportions. For the lesson from Bilbo Baggins is that the soul even of a greengrocer (though he is not, he might as well be) is capable of nourishment and growth.
And without this? In the reduced world, all insured, government regulated, tamed, domesticated and bled of all risk what happens to our souls? They become proportionate to that reality. By seeking to reduce the reality of evil the reality of a corresponding good is reduced. For evil has no positive and independent existence, as any serious Christian can tell you. Evil is a parasite, a deprivation of good, and the worse it is, the better is the good it preys on. Both must be, you see; at least the possibility of evil must exist (what mitigates it finally I think is a maturity of Wisdom, or as Jonathan Edwards might put it, true virtue: cordial consent of being to being in general).
You cannot tinker with reality. What you do when you try is not to reduce it, but to ignore it, and to ignore a part of what you were meant to know is to put out an eye, cut off a limb or let the corresponding faculty in your soul atrophy. Which may seem comfortable if you have never used that eye or that faculty of soul. But the goodness of what is, the startling grandeur and bright color and sheer unmitigated glory of what is is not something a healthy soul will trade away once it has gained it.
So good is what is real that it leads us quite beyond the Middle Earth–this land of appearances and symbols. We find that this world will not bear an endless growing, and that it has been designed purposefully that way. Which is why, eventually, Bilbo has to sail into the West: he has exceeded the limits of Middle Earth being involved in something far beyond his being, and he now needs a place with a more piercing greater goodness.
And so I think it must be with all of them. With Frodo and with Sam because they bore the ring, but do you think that great fellowship in the West will be complete without Meriadoc Brandybuck and Peregrin Took? I do not think so: they grew too, and I would be surprised if they did not at last outgrow the Shire, Rohan and Gondor, Middle Earth itself.
And so the hobbit now with glory dressed
shall never fade, but sail into the West.