The screen output looks so grainy because xdvi is not able to use its anti-aliasing features without enough colors. I have font files cmr10.tfm, etc. To obtain information about the shapes of the characters, xdvi needs pk or gf files. I can't seem to set the font path correctly. 32 file.dvi to find out where xdvi is looking for the fonts.
Virtual fonts are recipes for building fonts from other fonts.
In the case of PostScript fonts, those other fonts reside on your printer. There are some solutions, however. The first solution is to install gsftopk, which uses ghostscript to approximate the fonts. It is made for sites that use both xdvi and dvips, although if you just use xdvi it should be useful, too. Another solution is to get these fonts pre-made in common sizes.