Risk is a fact of everyday life. If people crossed busy streets with thesame inattention to detail that characterizes many investment portfolios, the body count would mount daily.

There are three possible responses to risk. One can ignore it, avoid it ormanage it. Ignoring risk is analogous to the supremely confident daredevilwho abruptly – and perilously – encounters an unexpected mishap.

Avoiding risk, by contrast, means never taking a chance on life, which is impossible. The person who hides from risk in the safest governmentsecurities endures the risk that inflation will insidiously peck away at his capital.

And you can’t really manage risk, because risk is the negative effect of unknown future events, just as fortune is the positive effect of unknown future events. The best you can do is manage your affairs so that negativeevents will cause the least possible damage while at the same time allowing the opportunity for positive events to be fortuitous.

In business, risk management is another term for buying appropriate insurance against possible losses. In recreation, risk management meanswearing your life jacket and a lifeline while hanging out over a sailboat’s gunnel.

The investing counterpart to risk management is based in the concept of diversity applied through a programmatic method known as asset allocation. Simply put, asset allocation means investing in asset classesthat in sum will reflect the investor’s objectives and tolerance for volatile performance.

The concept of diversity is easy – asset classes tend to perform in varying rhythms; some soar while others languish; some are spiked with volatility while others advance in a narrower, mellower range. Some make moneywhile others lose, and vice versa.

In asset allocation, the devil is in the details. What issues, within whichasset classes, according to whose objectives and needs…you would need abig computer to figure it all out. That’s what doctors of economics HarryMarkowitz and William Sharpe used when they discovered the “Efficient Frontier.” Their reward was the 1990 Nobel Prize in financial economicsand the undying gratitude of investors who have access to their thinking.

The work of Markowitz and Sharpe democratized the investment process that previously had been available only to very large institutional investors. Now individuals can benefit from advanced asset allocationtechniques of portfolio development.

The investor considering the asset allocation strategy seeks to either increase the return potential for any given level of risk, and/or decrease the level of risk while targeting a given return.

It should be noted that it is never possible to eliminate risk and that historic investment returns cannot predict future performance. But mostinvestors believe that historic performance gives them more to go on than do crystal balls or random numbers.

ALAN S. MOORE, who writes this column every Wednesday forL’Observateur, is a financial advisor with Legg Mason Wood Walker, Inc., adiversified financial services and securities brokerage firm that is a member of the New York Stock Exchange and SIPC.

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