activity. Otherwise, risk can be reallocated to achieve a portfolio with higher expected returns. The analogy between budgeting dollars in consumption and budgeting risk in portfolio construction is powerful, but one has to constantly keep in mind that in investing, risk is the scarce resource, not dollars. Unfortunately, many investors are not aware that such insights of modern portfolio theory have direct application to their decisions. Too often modern portfolio theory is seen as a topic for academia, rather than for use in real-world decisions. For example, consider a common situation: When clients of our firm decide to sell or take public a business that they have built and in which they have a substantial equity stake, they receive very substantial sums of money. Almost always they will deposit the newly liquid wealth in a money market account while they try to decide how to start investing. In some cases, such deposits stay invested in cash for a substantial period of time. Often individuals do not understand and are not comfortable taking investment risks with which they are not familiar. Portfolio theory is very relevant in this situation and typically suggests that the investor should create a balanced portfolio with some exposure to public market securities (both domestic and global asset classes), especially the equity markets. When asked to provide investment advice to such an individual, our first task is to determine the individual's tolerance for risk. This is often a very interesting exercise in the type of situation described above. What is most striking is that in many such cases the individual we are having discussions with has just made or is contemplating an extreme shift in terms of risk and return-all the way from one end of the risk/return spectrum to the other. The individual has just moved from owning an illiquid, concentrated position that, when seen objectively, is extremely risky7 to a money market fund holding that appears to have virtually no risk at all.8 Portfolio theory suggests that for almost all investors neither situation is a particularly good position to be in for very long. And what makes such situations especially interesting is that if there ever happens to be a special individual, either a very aggressive risk taker or an extremely cautious investor, who ought to be comfortable with one of these polar situations, then that type of investor should be the least comfortable with the other position. Yet we often see the same individual investor is comfortable in either situation, and even in moving directly from one to the other. The radically different potential for loss makes these two alternative situations outermost ends of the risk spectrum in the context of modern portfolio theory. And yet it is nonetheless difficult for many individuals to recognize the benefit of a more balanced portfolio. Why is that? One reason is that people often have a very hard time distinguishing between good outcomes and good decisions-and this is particularly true of good outcomes associated with risky investment decisions. The risk is of- 7Of course, perceptions of risk can differ markedly from objective reality. This topic has been recently investigated by two academics, Tobias Moskowitz and Annette Vising-Jorgensen, in a paper entitled, "The Returns to Entrepreneurial Investment: The Private Equity Premium Puzzle," forthcoming in the American Economic Review. 8We will come back to the important point that the short-term stability of the nominal pretax returns from a money market fund can actually create considerable real after-tax risk over longer periods of time.