followed by decreasing risk as they retire and draw down those savings. But even after accounting for differences in circumstances, age, country, taxes, and other measurable characteristics, there is a strong component of the tolerance for risk taking that simply depends on the preferences of the individual. Recognizing that risk is a scarce resource and that different investors have different appetites for risk, each investor needs to develop an individually tailored investment plan with a target level of risk for the portfolio based on the investor's preferences and circumstances. For most investment portfolios the dominant risk will be a relatively stable exposure to the traditional asset markets, especially equities and bonds. These long-term stable exposures to asset markets are referred to as the strategic asset allocation. The construction and management of a portfolio is simplified considerably when the investment plan is divided into two steps: first the development of a strategic asset allocation that leads to the creation of a benchmark, and second the implementation and monitoring of portfolio allocations relative to that benchmark. The strategic asset allocation is designed to be a stable asset mix that maximizes long-run expected return given a targeted level of risk. The strategic asset allocation is a high-level allocation to broad asset classes that determines the overall level of portfolio risk and will be the dominant determinant of long-run performance. For example, a very simple asset allocation might be 60 percent equity (i.e., stocks) and 40 percent bonds. A less risky allocation would be 50 percent equity and 50 percent bonds. Higher equity allocations will create more short-term volatility in the portfolio, but over long horizons can be expected to generate higher returns. Today most asset allocations also differentiate between domestic and foreign assets and might include other alternative assets such as real estate, private equity, or commodities, as well. In large institutional portfolios, the strategic asset allocation might include as many as 15 or more asset classes, although the complexity of trying to deal with too many asset classes can quickly outweigh any potential benefit. We will have much more to say about the process of developing a strategic asset allocation for institutions and individuals, respectively, in Chapters 9 and 31. Developing the strategic asset allocation is a topic for which the equilibrium approach, which we develop in Chapters 4, 5, and 6, can add considerable insight. Once the strategic asset allocation is set, the second step is to develop an implementation plan. This plan will vary depending on the nature of the investor, the size of the portfolio, and other constraints that might apply. Two particular issues that all such plans should focus on, though, are first, managing the costs associated with implementation, and second, budgeting and monitoring how much risk and return are generated relative to the strategic benchmark. A very important consideration that investors need to recognize is that the risk and return characteristics of asset class benchmarks are generally available at very low cost through passive index portfolios, derivative products, or exchange-traded funds (ETFs). Investors should not pay a significant management fee for such a benchmark exposure. These index products provide an efficient, and therefore attractive, way to implement asset allocation decisions. Over time, as these products have become available at low cost, a very significant amount of wealth has, appropriately, moved into passively managed index portfolios. Nonetheless, most money is still invested with active managers, managers who