it and manage it in ways to increase expected portfolio returns? Many investors assume, incorrectly, that the purpose of risk management is to minimize risk. In fact, many investors even go so far as to worry that too much focus on risk management will constrain their portfolio managers and inhibit their ability to generate positive returns. Nothing could be further from the truth. In an investment portfolio risk is necessary to drive return. The purpose of the risk management function is not to minimize risk, but rather is to monitor the level and sources of risk in order to make sure that they match expectations. In fact, an investor with strong risk management controls ought to feel more comfortable targeting and maintaining a higher overall level of risk, thus leading to higher, rather than lower, returns over time. Attention to risk management should be a positive contributor to portfolio return. For this to happen investors need to create an investment plan with which they are comfortable, and they need to follow that plan. The plan should have two components: an asset allocation and a risk budget. These two components of the investment plan are critical in defining its risk profile. They will also determine the long-run rate of return on the portfolio. Nonetheless, risk creates the capacity for losses, and along the path to long-run returns there will be painful bumps, losses of capital that will cause any investor to question the plan. One critical role that risk management can play in generating long-run returns is to provide comfort in such situations that a portfolio remains in adherence to the long-run plan so that the investor does not lose confidence and overreact to short-term market fluctuations. A useful way to think about risk in a portfolio is to view it as a scarce resource. Just as a family must budget its expenditures against its income, an investor must budget the risk in the portfolio relative to his or her limited ability to accommodate losses. Of course, some investors will be able to accept larger losses than others, so there is no single level of risk that is right for all investors. If we compare portfolios of investors in different countries and at different points in time, we see substantial differences in the average level of risk taken. Even within a particular country at a point in time there will be substantial differences across different investors, even those with the same degree of wealth. Over the course of their lives, many investors