IBF - Updates - 2007 (Q3 v2.0)

INSTITUTE OF BUSINESS & FINANCE

QUARTERLY UPDATES Q3 2007

Copyright © 2007 by Institute of Business and Finance. All rights reserved.

v2.0

Quarterly Updates Table of Contents U.S. STOCK MARKET MARKET UPDATE DIVIDEND POWER ROLLING PERIOD RETURNS MARKET-CAP CLASSIFICATIONS YEAR-END P/E RATIOS S&P 500 INFLECTION POINTS STOCKS VS. HOME VALUES VS. RENTING HOME PRICES CORRELATION COEFFICIENTS [OCTOBER 2003—MAY 2007] BEAR MARKET PERFORMANCE INVESTING JUST BEFORE A DISASTER STYLE AND MARKET CAPITALIZATION PROFESSOR PREDICTIONS

1.1 1.2 1.4 1.5 1.5 1.6 1.6 1.7 1.7 1.8 1.9 1.10 1.10

U.S. BONDS FIXED-INCOME SECTOR PERFORMANCE TAX-EXEMPT SECTOR RETURNS FIXED-INCOME CORRELATIONS FACTS ABOUT FLOATING-RATE BONDS MUNIS VS. TREASURIES FIXED-INCOME CORRELATIONS

2.1 2.2 2.3 2.4 2.5 2.6

MUTUAL FUNDS RETURNS AFTER TAXES FUNDS WITH CONSISTENCY TURNOVER AND TAX EFFICIENCY 2006 TAX EFFICIENCY OF 96% WHEN A FUND MANAGER LEAVES 130/30 FUNDS TARGET DATE FUND RUSSIAN ROULETTE CRITERIA FOR BUYING A SECTOR FUND FUND FAMILY RATINGS

3.1 3.1 3.3 3.4 3.4 3.4 3.5 3.5 3.6

ETFS AND CEFS ETF INDUSTRY STATISTICS UTILITY AND BOND ETFS INDEX FUNDS OUTPERFORM ETFS BOND ETFS BUY-WRITE STRATEGY CLOSED-END FUNDS

4.1 4.1 4.2 4.2 4.3 4.3

COLLEGE EDUCATION KIDDIE TAX EXTENDED COLLEGE FINANCIAL AID

5.1 5.1

HEALTH CARE HEALTH CARE PREMIUMS DOUBLE MEDICAID PLANNING UPDATE MEDICARE PART B PREMIUMS UNIVERSAL HEALTH CARE COVERAGE SPOUSAL MEDICAL COVERAGE

6.1 6.1 6.2 6.3 6.4

ANNUITIES 2006 ANNUITY SALES LIVING BENEFITS INCREASE SALES

7.1 7.1

RETIREMENT PLANNING ADVISOR INFO FROM SOCIAL SECURITY 2007 SOCIAL SECURITY UPDATE REQUIRED IRA WITHDRAWALS CALCULATING REQUIRED WITHDRAWALS

8.1 8.1 8.2 8.2

FOREIGN SECURITIES WORLD STOCK MARKET WEIGHTINGS WORLD ECONOMICS WORLD DEMOGRAPHICS FOREIGN OWNERSHIP OF TREASURIES PLAYING IT SAFE WITH CHINA VALUATION OF MAJOR WORLD MARKETS 20-YEAR STATISTICS [1987-2006] FOREIGN REAL ESTATE FUNDS

9.1 9.1 9.2 9.3 9.3 9.4 9.4 9.5

REAL ESTATE REVERSE MORTGAGE UPDATE REVERSE MORTGAGE CALCULATOR AVAILABLE TOP 5 REASONS SENIORS STILL HAVE A MORTGAGE HOME FOR RETIREMENT INCOME

10.1 10.2 10.2 10.2

EDUCATION ADVANCED DEGREE BENEFIT HOW ADULTS LEARN

11.1 11.1

QUARTERLY UPDATES U.S. STOCK MARKET

1.1

U.S. STOCK MARKET

1.MARKET

UPDATE

As of June 2007, the S&P 500 was trading at about 17 times its expected earnings over the next year窶馬ot much higher than its average (16 times earnings) since the 1930s. At the end of 1999, just before the market meltdown, its average P/E ratio was over 30. The dividend yield of the S&P 500 is roughly 1.8%, well below its historical average, but 60% higher than it was in 1999. Back then, technology stocks comprised a third of the value of the index, versus 15% today.

The current bull market is more than four years old; the S&P 500 is up 95% since the October 2002 market low. However, when compared to other asset categories, large U.S. stocks have been poor performers since the March 2000 market peak.

No stock is considered for the S&P 500 unless its market value is at least $4 billion. The average market capitalization is $28 billion (vs. $150 billion for the Dow). Additionally, only U.S. companies that are at least 50% owned by the public are included. On May 30th, 2007, the index beat its old 2000 record (1527.46) by 2.77 points. The table below shows cumulative returns of several market indexes.

Cumulative Returns [March 2000 to May 2007] Sector

Return

Sector

Return

Large Stocks

11%

Foreign Mkts.

47%

Small Stocks

65%

Emerging Mkts.

129%

REITs

332%

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U.S. STOCK MARKET

1.2

DIVIDEND POWER Dividend investing tends to be an unknown concept to investors raised during the high growth periods of the 1980s and 1990s. As you can see by the chart below, dividends have had a major impact on the total return of equities over the past several decades (note: ―Average Payout‖ refers to the percentage of a corporation’s profits that are paid out as a common or preferred stock dividend).

Dividend Contribution to Total Return Decade

Total Return

Dividend %

Average Payout

1950s

437%

41%

55%

1960s

108%

50%

56%

1970s

76%

77%

45%

1980s

370%

39%

49%

1990s

411%

23%

48%

2000s

-6%

n/a

32%

Even within the confines of GAAP (Generally Accepted Accounting Principals), corporations are able to present financial statements in the most favorable light.

But, companies that pay dividends must have the cash to do so.

From 1960 to 2006, $10,000 invested in the S&P 500 grew to $1,080,000; take away the dividends, the ending value would drop to $23,680 (source: Lipper). An interesting comparison with the S&P 500, long-term corporate bonds, and 30-day Treasury bills. Over the past 80 years (ending 2006), stock dividends had annualized returns of 4.3% (which represents 40% of the market’s overall return), versus a total return of 5.9% a year for bonds, and 3.7% for T-bills.

The chart below, provided by Ned Davis Research, shows that companies that consistently increased dividends had better returns than all dividend-paying stocks, plus dramatically outperformed non-dividend paying issues.

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1.3

U.S. STOCK MARKET

Returns for Stocks in the S&P 500 [1972-2006] Stock Description

Annualized

Dividend Growers and Initiators

11.0%

All Dividend Paying Stocks

10.3%

Dividend Payers—No Change in Dividends

7.2%

Dividend Cutters or Eliminators

3.6%

Non-Dividend Paying Stocks

2.4%

Since May 2003, when Congress reduced the dividend tax rate (to a maximum of 15%) to December 31st, 2006, companies in the S&P 500 had 1037 dividend increases and 41 initiators versus 22 decreases and eight suspensions. As of the third quarter of 2007, $300 billion was invested in dividend funds, a three-fold increase over the past five years. Roughly a quarter of these funds assets are invested in financial services companies (2.4% yield), 11% in energy stocks, and just 5% in utilities (3.2% yield). The dividend yield of the S&P 500 was 1.75% as of the middle of September 2007, down from 6.2% 25 years ago. The ―payout ratio,‖ the percentage of corporate earnings that gets paid out as dividends, was 29% for the second quarter of 2007.

Investors believe that dividend funds offer some safety during market turbulence.

Yet, during the month of August 2007, when stock markets were very volatile, dividend funds slightly underperformed diversified equity funds (+0.92% vs. +0.95%). For the 12 months ending August 31st, 2007, the 388 stocks in the S&P 500 that pay dividends had a total return of 13.8% versus 14.2% return for the remaining 122 non-dividend stocks. From the beginning of 1972 through the end of July 2007, dividend stocks experienced an average annual return of 10.2%, versus just 2.4% for non-dividend stocks, according to Ned Davis Research.

QUARTERLY UPDATES

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U.S. STOCK MARKET

1.4

ROLLING PERIOD RETURNS The two tables below show annualized returns for the S&P 500 (top table) and the Ibbotson small cap index from 1950 through the end of 2006. For the 57-year period, the standard deviation was 14.1 for the S&P 500 and 19.6% for the small cap stocks.

S&P 500 Rolling Periods [1950-2006] 3-Year

5Year

7Year

10Year

20Year

Maximum

33.4%

29.7%

23.1%

19.5%

18.3%

Median

11.9%

12.0%

12.2%

12.1%

11.5%

Low

-16.1%

-4.2%

-2.6%

0.5%

6.4%

High minus Low

49.5%

33.9%

25.7%

19.0%

11.9%

note: Annualized returns from 1/1/50 to 4/1/07 were 12.0%

Ibbotson Small Cap Stock Index [1950-2006] 3-Year

5Year

7Year

10Year

20Year

Maximum

44.5%

39.8%

35.8%

30.6%

20.3%

Median

15.5%

14.3%

14.5%

14.1%

14.1%

Low

-16.7%

12.3%

-7.8%

3.2%

8.2%

High minus Low

61.2%

52.1%

43.6%

27.4%

12.1%

note: Annualized returns from 1/1/50 to 4/1/07 were 12.0%

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1.5

U.S. STOCK MARKET

MARKET-CAP CLASSIFICATIONS There is no universal definition when it comes to stock market capitalization. The table below shows some examples of companies and how they are classified (source: Merrill Lynch). When talking to clients, it may be helpful to give them examples of companies that represent the market capitalizations you are recommending.

Market Capitalization [# of shares x share price] Market Cap

Sample Companies

Over $100b

Mega

IBM, P & G, GE

$10b—$100b

Large

Coach, Starbucks, GM

Mid

$2b—$10b

Ann Taylor, JetBlue, Barnes & Noble

Small

< $2b

Panera Bread, palmOne, Gateway

YEAR-END P/E RATIOS The table below shows the year-end price/earnings ratios for the S&P 500 (S&P) and Dow Jones Industrial Average (DJIA) from the end of 1987 to the end of 2006 (sources: S&P and Barron’s Online).

Year-End P/E Ratios: S&P 500 and DJIA Year

DJIA 17.1

Year

2006

S&P 17.4

1996

S&P 19.1

DJIA 18.2

2005

17.9

22.5

1995

18.1

16.4

2004

20.7

18.3

1994

15.0

15.0

2003

22.8

20.1

1993

21.3

25.6

2002

31.9

21.6

1992

22.8

30.5

2001

46.5

27.1

1991

26.1

34.3

2000

26.4

22.2

1990

15.5

15.3

1999

29.2

24.1

1989

15.5

12.4

1998

32.6

24.0

1988

11.7

10.1

1997

24.4

20.2

1987

20.3

14.6

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U.S. STOCK MARKET

1.6

S&P 500 INFLECTION POINTS From the beginning of 1997 through the first half of 2007, the S&P 500 has: [1] grown from less than 800 to 1,503; [2] seen its P/E (trailing earnings) ratio peak at 31 (3/24/2000); [3] peaked at 1,527 (3/24/2000); [4] experienced a decline of 49% (3/24/2000 to 10/9/2002); [5] seen a 94% increase from its 10/9/2002 low (777 to 1,503); [6] had a P/E (trailing earnings) of 18.1 on 6/30/2007; and [7] 1.6% more to go before matching its 3/24/2000 peak.

STOCKS VS. HOME VALUES VS. RENTING For the 1987-1991 period, the price of residential rents annually increased by 4.7% versus 3.8% for home appreciation; from 1992-1996, rents went up each year an average of 3.2% versus 3.7% for housing prices. For the 1997-2001 period, rents went up 3.3% a year versus 6.3% yearly appreciation for homes; from 2002-2006, rents were up an average of 2.9% a year versus 6.9% annual appreciation for homes. Thus, from 1997 to the beginning of 2007, renting was considered a â&#x20AC;&#x2022;good dealâ&#x20AC;&#x2013; when compared to real estate appreciation.

The table below covers the period 12/31/86 through 12/31/06. The figures are based on the S&P 500 and the median sales price of existing one-family homes.

As you can see, large cap stocks, as represented by the S&P 500, greatly outperformed the average American home. Moreover, the residential real estate figures do not factor in the negative consequences of: debt service, insurance, repairs, maintenance, remodeling, or the eventual sales fee and closing costs that typically total 7% (sources: S&P, NAR, BLS, FactSheet, and JP Morgan Asset Management).

Stocks vs. Homes 20-year Return

Inflation Real 1986 2006 (CPI) Return Value Value

S&P 500 Index

11.8%

3.0%

8.8%

$100

$931

Residential Real Estate

5.2%

3.0%

2.2%

$100

$274

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1.7

U.S. STOCK MARKET

HOME PRICES The index produced by the Office of Federal Housing Enterprise Oversight, based on millions of loans purchased by Fannie Mae and Freddie Mac over the past 30 years, is considered to one of the best measures of house prices in the U.S. According to this index, housing prices have increased every quarter since 1993.

During 2006, prices increased about 4%.

Residential real estate represents more than a third of the total value of domestic assets, according to the Chicago Mercantile Exchange; the second largest asset class is fixed income investments. Starting in 2006, the Chicago Mercantile Exchange began offering a suite of futures contracts based on the S&P/CaseShiller housing indexes.

These contracts track 10 metropolitan areas: Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco, and Washington, D.C.—plus a U.S. composite benchmark. Robert Shiller of Yale University and Karl Case of Wellesley College developed these real estate benchmarks. The table below shows the correlation between San Francisco housing and a number of other indexes.

Correlation Coefficients [October 2003—May 2007] S.F. Housing

Bonds

Stocks

S.F. Housing

---

Bonds

-0.12

---

Stocks

-0.20

-0.03

---

REITs

-0.12

-0.05

-0.03

REITs

---

Before recommending any of the S&P/Case-Shiller real estate futures contracts to any of your clients, keep in mind the following risk considerations: [1] there may be a tracking error between the contract’s underlying index and the value of a given home; [2] areas outside a metropolitan area are subject to unique price dynamics; [3] the amount of money needed to fulfill the initial margin requirement can be high;

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U.S. STOCK MARKET

1.8

[4] there may be a substantial amount of time between hedging and the actual sale of the home—time that the hedging client is paying for; [5] the real estate futures contracts can be highly leveraged and additional cash may be needed quickly (to maintain the minimum amount of collateral in the account); [6] the furthest available contract is less than a year out (the client can always buy other contracts in the future); [7] any futures contract needs to be monitored daily; and [8] commodities (futures contracts) commissions need to be factored in (as well as any bid-ask spread if a soon-to-expire contract is going to be replaced with a new contract that has greater longevity).

BEAR MARKET PERFORMANCE As shown below, stock (S&P 500) and bond (Merrill Lynch U.S. Corporate and Government Master Index) returns often move in different directions. The figures below are cumulative returns (sources: Lipper and Bloomberg).

Bear Market Returns Bear Market

S&P 500

U.S. Bonds

Jan. ’77 — Feb. ‘78

-14.2%

3.2%

Dec. ’80 — July ‘82

-17.2%

21.0%

Sept. ’87 — Nov. ‘87

-29.6%

2.3%

June ’90 — Oct. ‘90

-14.7%

3.7%

May ’98 — Aug. ‘98

-13.4%

4.2%

Mar. ’00 — Dec. ‘02

-33.0%

33.1%

Average for Above

-23.5%

11.2%

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1.9

U.S. STOCK MARKET

INVESTING JUST BEFORE A DISASTER The table below shows subsequent S&P 500 returns if an investment had been made the day before the disaster shown. For example, an investment in the S&P 500 made one day before President Kennedy’s assassination grew by 79% five years later, 97% 10 years later, and 815% by the end of 2006.

S&P 500 Cumulative Returns Event

5 Years

10 Years

12/31/06

Great Depression (1/1/34)

66%

100%

252,900%

Pearl Harbor (12/7/41)

105%

348%

179,100%

JFK Assassination (11/22/63)

79%

97%

8,250%

Vietnam Escalation (8/10/64)

35%

37%

6,860%

Nixon Resignation (8/9/74)

65%

235%

4,910%

1987 Market Crash (10/19/87)

189%

463%

879%

Iraq Invades Kuwait (8/2/90)

85%

417%

467%

Tech Bubble Burst (3/24/00)

-17%

——

4%

Terrorists Attack U.S. (9/11/01)

30%

——

42%

U.S. Invades Iraq (3/20/03)

——

——

73%

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U.S. STOCK MARKET

1.10

STYLE AND MARKET CAPITALIZATION The table below shows annualized returns for the Dow Jones Wilshire Index for the period 1982-2006. As you can see, ―blend‖ outperformed its ―value‖ and ―growth‖ counterparts; similarly, ―mid‖ cap stocks did better than ―large‖ or ―small‖ cap issues. For the entire 25-year period, the Dow Jones Wilshire 5000 Equity Index averaged 10.1% a year versus 13.5% for the Dow Jones Wilshire U.S. Micro-Cap Index (source: Bloomberg).

Style and Market Cap Returns [1982-2006] Value

Blend

Growth

Large

12.7%

13.7%

10.6%

Mid

14.9%

15.5%

11.9%

Small

10.3%

15.0%

6.3%

PROFESSOR PREDICTIONS As of the middle of 2007, Burton Malkiel, a professor of economics at Princeton University and author of A Random Walk Down Wall Street, believes that U.S. stocks are poised to return about 7.5% year in the future (2% stock dividend plus earnings growth of about 5.5% annually). Such a return would be well below the market’s historical returns from 1926 through 2006 of 10.5% annually (4.75% for Treasury bond yields).

The share of after-tax corporate profits, increasingly influenced by the foreign profits of multinational corporations, is almost 9% relative to GDP, versus an average of about 5% during the 1970s and 1980s. Wages and salaries has a percent of GDP have fallen from 53% to under 46% since 1970. Corporate profits have shown strong tendencies to revert to the mean in the past. Inflation-adjusted earnings of the S&P 500 showed zero growth from 1900 through 1947 and again from 1967 through 1987.

According to Yale University economist Robert Shiller, inflation- and qualityadjusted home prices are still more than 50% higher than their averages throughout most of the 20th century. Such data suggests that the real estate correction could last much longer than expected.

QUARTERLY UPDATES

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QUARTERLY UPDATES U.S. BONDS

2.1

U.S. BONDS

2.FIXED-INCOME

SECTOR PERFORMANCE

The table below shows the total annual returns of fixed-income indexes, ranking in order of performance (best to worst) for the period 1997-2006 (sources: Lipper, Merrill Lynch, and S&P).

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

HY 13.3

Treas.

10.0

Cash 4.7

Muni 17.1

LD 8.7

Treas.

11.6

HY 28.1

HY 10.9

Muni 3.9

HY 11.8

Muni 10.9

Inv. G 8.9

LD 3.2

Treas.

13.4

Inv. G 8.3

Muni 10.7

Muni 6.2

Muni 5.4

Cash 3.0

Muni 5.0

Inv. G 9.6

Muni 7.1

HY 2.5

Inv. G 11.7

Treas.

6.7

Inv. G 10.4

Inv. G 4.1

Inv. G 4.3

Treas.

2.8

Cash 4.8

Treas.

9.6

LD 7.0

Inv. G –1.0

LD 8.1

HY 4.5

LD 6.1

LD 2.7

Treas.

3.5

HY 2.7

Inv. G 4.3

LD 6.7

Cash 5.1

Treas.

–2.4

Cash 6.0

Muni 4.5

Cash 1.7

Treas.

2.3

Cash 1.2

Inv. G 2.5

LD 4.2

Cash 5.3

HY 3.0

Muni –6.4

HY – 5.1

Cash 4.1

HY – 1.9

Cash 1.1

LD 1.2

LD 1.7

Treas.

3.1

HY: ML U.S. High-Yield Master Index Cash: ML U.S. Treasury bill 0-3 Month Index Treas.: ML Treasury Bill Master Index Muni: ML Municipal Master Index LD: ML 1-3 Corporate & Government Index (low duration) Inv. G: ML U.S. Domestic Master Index (investment grade)

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U.S. BONDS

2.2

TAX-EXEMPT SECTOR RETURNS The table below shows the total annual returns of municipal bond indexes, ranking in order of performance (best to worst) for the period 1997-2006 (sources: Lipper, Merrill Lynch, and S&P).

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

22+ 11.5%

12-22 7.3%

1-3 2.5%

22+ 18.6%

1-3 6.0%

7-12 11.5%

12-22 6.6%

22+ 6.2%

22+ 6.8%

22+ 6.6%

12-22 11.2%

22+ 7.2%

3-7 0.7%

Index 17.1%

3-7 6.0%

12-22 11.0%

22+ 6.4%

12-22 6.1%

12-22 4.4%

12-22 5.3%

Index 10.9%

Index 7.1%

7-12 – 1.2%

12-22 15.6%

12-22 4.6%

Index 10.7%

Index 6.2%

Index 5.4%

Index 3.9%

Index 5.0

7-12 9.0%

7-12 6.8%

12-22 –4.4%

7-12 11.3%

7-12 4.5%

22+ 10.7%

7-12 5.6%

7-12 4.2%

7-12 2.8%

7-12 4.6%

3-7 6.5%

3-7 5.9%

Index –6.4%

3-7 8.2%

Index 4.5%

3-7 10.1%

3-7 4.2%

3-7 2.9%

3-7 1.4%

3-7 3.4%

1-3 4.7%

1-3 5.0%

22+ -7.6%

1-3 5.7%

22+ 4.3%

1-3 5.0%

1-3 2.1%

1-3 1.3%

1-3 1.3%

1-3 3.2%

22+: 22+ Year Municipal Securities Index 12-22: 12-22 Year Municipal Securities Index 7-12: 7-12 Year Municipal Securities Index 3-7: 3-7 Year Municipal Securities Index Index: ML Municipal Master Index (investment-grade muni bonds)

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2.3

U.S. BONDS

FIXED-INCOME CORRELATIONS The table below shows the correlation coefficients for six different bond categories for the 30-year period, 1977-2006 (sources: Bloomberg and Lipper LANA). High-yield bonds have the lowest correlation to other bond categories, followed by emerging markets debt.

Bond Category Correlations [1977-2006] Treas.

Mort.

Corp.

Munis

Emerg.

HY

Treas.

1.0

0.9

0.9

0.8

0.1

0.0

Mort.

0.9

1.0

0.8

0.7

0.2

0.1

Corp.

0.9

0.8

1.0

0.8

0.3

0.4

Munis

0.8

0.7

0.8

1.0

0.2

0.2

Emerg.

0.1

0.2

0.3

0.2

1.0

0.5

HY

0.0

0.1

0.4

0.2

0.5

1.0

Over this same 30-year period (1977-2006), these six categories had the following annualized returns and risk (standard deviation shown in parentheses): U.S. Treasuries — 6.0% (4.4) Mortgage-Backed Securities — 6.2% (2.6) Municipals — 6.3% (5.1%) Yield Corporates — 6.6% (7.2) — 6.6% (4.6) 10.7% (13.8)

HighCorporate Quality Emerging Markets —

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U.S. BONDS

2.4

FACTS ABOUT FLOATING-RATE BONDS By the end of 2006, there was close to $1.5 trillion of outstanding floating-rate loans. Floating-rate bonds have historically provided very good risk-adjusted returns and a low correlation to other asset classes. However, their lower credit quality and the overall complexity of their marketplace make this a difficult investment.

Floating-rate bank loans are structured by banks and other lenders to help companies finance restructurings, acquisitions, or other highly leveraged transactions. The interest rate of floating-rate loans are periodically reset, usually quarterly, to an underlying benchmark rate, such as the prime rate or the London Interbank Offered Rate (LIBOR). Most loans are priced to spread relative to the underlying benchmark rate.

Floating-rate loans are typically the most senior source of capital of the borrower.

The loans are also secured by the borrowerâ&#x20AC;&#x2122;s capital, which places them first in line for repayment if a bankruptcy or liquidation of assets occurs. From 1997 to 2006, even in default, the recovery rate on these loans was roughly 70¢ on the dollar; a rate significantly higher than high-yield bonds over the same period, according to a 12/31/2006 report by Credit Suisse.

Over the ten years ending 12/31/2006, floating-rate securities have been less volatile than corporate bonds, as measured by standard deviation (2.1 vs. 4.5), according to S&P Micropal. The correlation to other asset categories has also been low, as shown in the table below (source: S&P Micropal).

Correlation to Other Asset Categories [5-year period ending 12/31/2006] Asset Category

Fixed-Rate Loans

Investment-Grade Corporates

0.1

U.S. Government Bonds

-0.1

U.S. Equities

0.3

Foreign Equities

0.4

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2.5

U.S. BONDS

MUNIS VS. TREASURIES In theory, municipal bond yields should equal treasury yields multiplied by one minus the investor’s tax rate. From 1994 through June 2007, the yield on municipal bonds has ranged from about 81% to 83.5%. During this same period of time, the percentage has been as low as 77% (1995 and 1998) to as high as 95% (2004). Using the June 2007 figure of 83.5%, this means that if your client’s federal tax bracket is 16.5% or higher (1.0 – 16.5 = 83.5), a national municipal bond portfolio should be considered.

If the after-tax return of the treasuries is the same or slightly higher than what a national municipal bond fund, UIT, or CEF is offering, choosing the tax-free portfolio may still be the better risk choice. As the table below shows, municipal bond interest rate sensitivity is usually dramatically lower than that of treasuries (the exceptions being 2005 and the first half of 2007) The table shows the change in yield (bps) of U.S. Treasuries vs. municipals (source: FactSet).

Interest Rate Sensitivity [1994-2007] Year

Treasury

Muni

Year

Treasury

Muni

1994

203

134

2001

-6

4

1995

-225

-116

2002

-124

-81

1996

85

11

2003

43

-12

1997

-68

-34

2004

-4

2

1998

-109

-27

2005

18

25

1999

179

95

2006

32

0

2000

-133

-60

6/30/07

33

36

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2.6

FIXED-INCOME CORRELATIONS The table below shows the five-year correlation coefficient for different bond categories plus the S&P 500 (source: S&P Micropal).

5-Year Correlations [ending 12/31/2006] T

MBS

C

HY

I

TIPS

Muni

FR

S&P

T

1.0

0.9

0.9

0.0

0.5

0.9

0.9

-0.1

-0.4

MBS

0.9

1.0

0.8

0.1

0.5

0.7

0.9

-0.2

-0.3

C

0.9

0.8

1.0

0.3

0.5

0.9

0.9

0.1

-0.1

HY

0.0

0.1

0.3

1.0

0.1

0.0

0.1

0.7

0.5

I

0.5

0.5

0.5

0.1

1.0

0.6

0.5

0.0

-0.1

TIPS

0.9

0.7

0.9

0.0

0.6

1.0

0.8

0.0

-0.3

Muni

0.9

0.9

0.9

0.1

0.5

0.8

1.0

0.0

-0.4

FR

-0.1

-0.2

0.1

0.7

0.0

0.0

0.0

1.0

0.3

S&P

-0.4

-0.2

-0.1

0.5

-0.1

-0.3

-0.4

0.3

1.0

T = Treasuries MBS = Mortgage-Backed Securities C = Investment-Grade Corporates HY = High-Yield Bonds I = International Bonds TIPS = Treasury Inflation-Protected Securities Muni = Municipal Bonds FR = Floating-Rate Loans S&P = S&P 500

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3.1

MUTUAL FUNDS

3.RETURNS

AFTER TAXES

The table below shows returns before and after taxes for index funds. It is assumed that all distributions are taxed at a 35% tax rate; it is also assumed that the investor does not sell any shares and that the expense ratio of the index fund is low. The return figures shown in parentheses are after-tax returns.

Index Mutual Funds: Before and After-Tax Returns [all periods ending 12-31-2006] Index Fund

1 Year

5 Years

10 Years

Total U.S. Market

15.5% (15.2%)

3.4% (7.4%)

7.1% (8.1%)

Growth

9.0% (8.9%)

3.4% (7.1%)

7.1% (8.8%)

Value

22.1% (21.7%)

9.5% (9.1%)

9.5% (8.1%)

Small Cap Value

19.2% (18.8%)

13.0% (12.3%)

10.2% (8.9%)

Small Cap Growth

11.9% (11.9%)

11.2% (11.2%)

8.1% (7.9%)

Small Cap

15.6% (15.4%)

11.6% (11.3%)

10.0% (8.8%)

Mid Cap

13.6% (13.4%)

12.3% (12.0%)

11.8% (10.7%)

REITs

35.1% (33.6%)

22.7% (20.7%)

14.2% (12.0%)

FUNDS WITH CONSISTENCY One reason to select an actively-managed mutual fund is performance consistency.

Your clients can end up with much more money if you select funds that have consistent results as opposed to those that have wild swings. A 2007 Morningstar study looked at 14 categories (the 9 U.S. style-boxes, 3 large cap foreign stock groups, the intermediate bond and intermediate-government bond groups) and did not include survivorship bias.

Morningstarâ&#x20AC;&#x2122;s looked at how frequently a fund outperformed its category median over rolling one-, three- and five-year periods. It turns out that the most consistent funds delivered top-quartile results more often than those with the best trailing returns in 10 out of the 14 categories reviewed.

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3.2

The table below shows the mutual funds that were the most consistent winners, as defined by the frequency of being in the top-quartile of results for the periods from August 1994 through the end of February 2007. All of the funds shown below had a Morningstar consistency rating of 100 for all five-year rolling periods which the fund outperformed its peers.

Consistent Performers [1994-2007] Fund Name

Category

EuroPacific Growth

foreign large blend

0.8

Davis NY Venture A

large blend

0.9

Dodge & Cox Income

intermediate bond

0.4

Fidelity Government

intermediate govâ&#x20AC;&#x2122;t

0.4

Harbor International Institution

foreign large value

0.9

Met West Total Return Bond

intermediate bond

0.7

Oakmark Select I

large blend

1.0

Sound Shore

large value

0.9

T. Rowe Price Equity Income

large value

0.7

T. Rowe New American Growth

large growth

0.9

TCW Total Return Bond I

intermediate bond

0.4

USAA International

foreign large blend

1.2

Vanguard Mid Cap Index

mid-cap blend

0.2

Vanguard Select Value

mid-cap value

0.5

Vanguard Tax-Man Small Cap

small blend

0.1

Expense

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3.3

MUTUAL FUNDS

TURNOVER AND TAX EFFICIENCY The financial press emphasizes the ―connection‖ between a mutual fund’s turnover rate and its after-tax returns. The belief is that the higher the turnover, the less tax efficient the fund. The discussion never includes the fact that the sale of losing securities can offset realized gains, dollar for dollar.

The reality is that mutual fund can have quite a bit of selling activity that generates tax losses that may offset some, most, or all of securities sold for a profit. Equally important, large gains may be due to securities in the portfolio that have enjoyed substantial appreciation but are still owned by the fund. Such paper profits are not taxed since no gain (or loss) has yet been realized.

The table below shows turnover and tax efficiency for a handful of equity mutual funds; performance figures and rankings are through the end of February 2007. All of the funds shown are either mid or large cap growth, value, or blend. As you can see, a fund can have very high turnover and still be extremely tax efficient.

For example, over the past five years, Eaton Vance Growth A averaged 10.60% per year before taxes and 10.53% after taxes (the rate assumes the investor did not sell his or her shares). Even though this fund experienced an annual turnover rate of 208%, its tax efficiency was quite a bit higher than what is considered a tax efficient fund, Vanguard 500 Index, which had an annual tax cost that was five times greater than the Eaton Vance fund (0.36 vs. 0.07%).

Annual Turnover vs. Tax Efficiency Annual Turnover

Annual Tax Cost

5-Year Return

Category Ranking

Amer. Century Heritagel

230%

0.21%

10.6%

top 23%

Aston/Veredus Select Gr.

270%

0.01%

8.0%

top 9%

Eaton Vance Growth A

208%

0.07%

10.6%

top 24%

Fidelity Large Cap Value

175%

0.71%

10.2%

top 17%

Wells Fargo Adv. Gr. Inv.

123%

0.00%

7.7%

top 11%

5%

0.36%

6.7%

top 42%

Fund Name

Vanguard 500 Index

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3.4

2006 TAX EFFICIENCY OF 96% The average capital gains distribution from a U.S. stock fund for the 2006 calendar year was just under 4.2%. Assuming the maximum capital gains tax rate of 15%, this means that investors were able to keep 3.6% of the 4.2% distribution. This means that domestic equity fund investors had a gross return of 15.9% (assuming such funds had the same 2006 return as the S&P 500) and an after-tax return of 15.3%. Phrased another way, shareholders enjoyed a tax efficiency of 96% (15.3/15.9).

WHEN A FUND MANAGER LEAVES According to a study by Standard & Poor’s, the average tenure of a large company stock fund was 5.6 years, for the five years ending 12/31/2006. The managers whose performance consistently ranked in the top half had an average tenure of 9.5 years. In a different S&P study, manager tenure was ―a primary differentiator‖ of the funds that beat their peers or index.

130/30 FUNDS A 130/30 fund may invest X amount in a basket of stocks, such as the S&P 500 and then short 30% of X in different stocks. This means the fund uses leverage and borrows 30% to short those stocks or baskets of equities it believes are overvalued.

Proceeds from the short sale, 30% in this example, are then used to buy more stocks. When fully implemented, $10 million of assets has purchased $130 million of equities and shorted $30 million of other securities. There are also other variations of this theme, such as a 120/20 fund (120% long and 20% short).

A number of well-known companies offer such leveraged funds, including Barclays, ING, State Street, UBS, Martingale, Goldman Sachs, J.P. Morgan, MainStay funds, Dreyfus, and BlackRock Advisors. A March 2007 report from Merrill Lynch indicates that roughly $50 billion is invested in 130/30 strategies; with a sizeable amount coming from pension plans.

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3.5

MUTUAL FUNDS

TARGET DATE FUND RUSSIAN ROULETTE Opinions vary as to how much a target date fund should have in equities. Some funds that have a target retirement date of 2045 have close to 95% of their assets in common stocks. There is also criticism as to what type of bonds should comprise the fixed-income portion. A couple of fund families feel that the lowest risk asset should be TIPS rather than cash equivalents. What is receiving little press is ―the luck of the draw‖—when an investor actually retires.

For example, someone born in 1919 who retired at age 65 would have experienced an annual return of just 2.2% above inflation while someone born in 1935 who retired in 2000 would have earned an inflation-adjusted 9.3% per year.

Using the same contributions, the person born in 1935 ended up with a lump sum that was four times greater than the worker born 16 years earlier. The annual income of the person born in 1919 came out to $9,630 a year versus $38,580 for the worker who was born in 1935.

CRITERIA FOR BUYING A SECTOR FUND The most important criteria for selecting any mutual fund once the category has been determined is strong management, a strategy that makes sense, and a low expense (if possible). In the case of sector funds, there are four additional guidelines: [1] Be a contrarian—do not chase a hot sector or fund.

[2] Must fulfill an objective—do not buy based on returns alone.

[3] Experience—most have management with limited experience.

[4] Long-Term hold—five year minimum; advise a hold of 10 years.

10 Sector Funds Favored By Morningstar — July 2007 [manager tenure in years shown in parentheses] Allianz RECM Technology Instl (11.6)

T. Rowe Price Media & Telecom (2.3)

Davis Financial (5.2)

T. Rowe Price Real Estate (9.8)

JP Morgan U.S. Real Estate A (10.3)

Third Ave. Real Estate Value (8.8)

T. Rowe Price Financial Services (—)

Vanguard Health Care (23.2)

T. Rowe Price Health Sciences (7.5)

Vanguard Precious Metals Mining (11.1)

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3.6

FUND FAMILY RATINGS The next 33 pages are a rating directory of mutual fund families. You may wish to print out these pages and use them as an ongoing mutual fund reference source.

The following information is included for each of the 98 fund groups covered: [1] rating of ownership costs (e.g., low, average, etc.)

[2] number of funds in family and inception date [3] fund family assets under management [4] equity management style [5] stock funds’ risk level and return (e.g., low, high, etc.)

[6] bond funds’ risk level and return [7] toll-free phone number

ALGER [800.992.3863] inception: 1964 number of funds: 19 total assets: $5 billion

stock funds’ risk level: high stock funds’ return: above average bond funds’ risk level: no bond funds bond funds’ return: no bond funds

ownership costs: average

equity management: emphasis on in-house research and high growth stocks; started offering funds in 1986

ALLEGIANT [800.622.3863] inception: 1986 number of funds: 26 total assets: $17 billion

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: very low

ownership costs: very low

bond funds’ return: above average

equity management: bottom-up and/or top-down

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MUTUAL FUNDS

ALLIANCE CAPITAL [800.247.4154] inception: 1962 number of funds: 66 total assets: $660 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: above average bond funds’ return: above average

equity management: bottom-up emphasis with some top-down

AMERICAN CENTURY [800.378.9878] inception: 1958 number of funds: 67 total assets: $110 billion ownership costs: very low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: above average bond funds’ return: high

equity management: bottom-up and/or top-down

AMERICAN FUNDS [800.421.4120] inception: 1932 number of funds: 25 total assets: $875 billion ownership costs: low

stock funds’ risk level: low stock funds’ return: below average bond funds’ risk level: average bond funds’ return: average

equity management: multiple-portfolio counselor; buy-and-hold

ARTISAN [800.344.1770] inception: 1995 number of funds: 8 total assets: $13 billion ownership costs: low

stock funds’ risk level: high stock funds’ return: below average bond funds’ risk level: no bond funds bond funds’ return: no bond funds

equity management: bottom-up with an emphasis toward value

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3.8

ASTON [800.992.8151] inception: 1997 number of funds: 19

stock funds’ risk level: average stock funds’ return: above average bond funds’ risk level: average bond funds’ return: below average

total assets: $7 billion ownership costs: low equity management: fundamental analysis

AXA [800.432.4320] inception: 1987 number of funds: 41

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: average bond funds’ return: high

total assets: $5 billion ownership costs: average

equity management: mostly oversees institutional accounts

BB&T [800.228.1872] inception: 1992 number of funds: 22 total assets: $5 billion ownership costs: average

stock funds’ risk level: low stock funds’ return: below average bond funds’ risk level: below average bond funds’ return: above average

equity management: quantitative growth and value offerings

BJURMAN [800.227.7264] inception: 1970 number of funds: 3 total assets: $3 billion ownership costs: low

stock funds’ risk level: high stock funds’ return: high bond funds’ risk level: no bond funds bond funds’ return: no bond funds

equity management: capital appreciation using quantitative factors

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MUTUAL FUNDS

BLACKROCK [800.441.7762] inception: 1990 number of funds: 89

stock funds’ risk level: average stock funds’ return: average

total assets: $1.1 trillion bond funds’ risk level: average ownership costs: below average bond funds’ return: average equity management: fundamental top-down and bottom-up

BNY HAMILTON [800.426.9363] inception: late 1700s number of funds: 15 total assets: $18 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: below average bond funds’ return: high

equity management: offshoot of Bank of New York, which was founded by Alexander Hamilton; offers both topdown growth and value funds

BRIDGEWAY CAPITAL [800.661.3550] inception: 1993 number of funds: 11 total assets: $4 billion ownership costs: low

stock funds’ risk level: high stock funds’ return: above average bond funds’ risk level: no bond funds bond funds’ return: no bond funds

equity management: quantitative factors using computer programs

BUFFALO [800.492.8332] inception: 1994 number of funds: 9 total assets: $3 billion ownership costs: very low

stock funds’ risk level: above average stock funds’ return: above average bond funds’ risk level: above average bond funds’ return: low

equity management: fundamental analysis using proprietary model

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3.10

CALAMOS [800.823.7386] inception: 1977 number of funds: 15 total assets: $900 billion ownership costs: average

stock funds’ risk level: above average stock funds’ return: above average bond funds’ risk level: high bond funds’ return: average

equity management: emphasis on convertibles; uses top-down and bottom-up

CALVERT [800.368.2745] inception: 1976 number of funds: 18 total assets: $14 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: high bond funds’ risk level: low bond funds’ return: below average

equity management: socially-responsible small-, mid-, and large cap offerings

COLUMBIA [800.426.3750] inception: 1967 number of funds: 79 total assets: $105 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: below average bond funds’ risk level: above average bond funds’ return: high

equity management: top-down and/or bottom-up

CREDIT SUISSE [800.927.2874] inception: 1971 number of funds: 27 total assets: $300 billion ownership costs: low

stock funds’ risk level: low stock funds’ return: average bond funds’ risk level: above average bond funds’ return: high

equity management: bottom-up growth and value offerings

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3.11

MUTUAL FUNDS

DAVIS [800.279.0279] inception: 1969 number of funds: 6 total assets: $44 billion ownership costs: low

stock funds’ risk level: low stock funds’ return: low bond funds’ risk level: very low bond funds’ return: above average

equity management: fundamental-value approach

DELAWARE [800.523.1918] inception: 1938 number of funds: 62 total assets: $130 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: above average bond funds’ return: below average

equity management: bottom-up growth and value styles

DIMENSIONAL FUND ADVISORS [800.342.6684] inception: 1981 number of funds: 21 total assets: $50 billion ownership costs: very low

stock funds’ risk level: above average stock funds’ return: below average bond funds’ risk level: low bond funds’ return: below average

equity management: academic approach to specific benchmark indexes; minimum $50,000 shareholder investment

DODGE & COX [800.621.3979] inception: 1930 number of funds: 4 total assets: $130 billion ownership costs: very low

stock funds’ risk level: below average stock funds’ return: low bond funds’ risk level: very low bond funds’ return: very low

equity management: emphasis on well-established companies

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3.12

DREYFUS [800.782.6620] inception: 1951 number of funds: 108 total assets: $48 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: average bond funds’ return: average

equity management: variety of investment approaches

DWS SCUDDER [800.621.1048] inception: 1928 number of funds: 75 total assets: $675 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: average bond funds’ return: below average

equity management: quantitative research with a strong global perspective; offered first international fund in the U.S. (1952)

EATON VANCE [800.262.1122] inception: 1931 number of funds: 93 total assets: $135 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: below average bond funds’ return: high

equity management: all managers have at least 20 years of experience; pioneer of tax-managed investing

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MUTUAL FUNDS

EVERGREEN [800.343.2898] inception: 1932 number of funds: 56 total assets: $275 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: average bond funds’ return: average

equity management: managers on five continents

EXCELSIOR [800.446.1012] inception: 1853 number of funds: 21 total assets: $20 billion ownership costs: lov

stock funds’ risk level: above average stock funds’ return: below average bond funds’ risk level: below average bond funds’ return: average

equity management: investment advisor, U.S. Trust, was founded in 1853; bottom-up approach uses both value and growth strategies

FEDERATED INVESTORS [800.341.7400] inception: 1955 number of funds: 66 total assets: $250 billion ownership costs: low

stock funds’ risk level: below average stock funds’ return: average bond funds’ risk level: below average bond funds’ return: below average

equity management: bottom-up emphasis varies depending on fund

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3.14

FIDELITY INVESTMENTS [800.522.7297] inception: 1946 number of funds: 182 total assets: $1.3 trillion ownership costs: very low

stock funds’ risk level: average stock funds’ return: above average bond funds’ risk level: average bond funds’ return: below

equity management: emphasizes structure over individual stock selection; largest fund family in the U.S.

FIFTH THIRD [800.282.5706] inception: 1988 number of funds: 26 total assets: $7 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: above average bond funds’ risk level: low bond funds’ return: above average

equity management: bottom up

FIRST AMERICAN [800.677.3863] inception: 1967 number of funds: 44 total assets: $75 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: average bond funds’ return: average

equity management: team approach uses fundamental analysis

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3.15

MUTUAL FUNDS

FIRST EAGLE [800.334.2145] inception: 1987 number of funds: 5 total assets: $33 billion ownership costs: average

stock funds’ risk level: very low stock funds’ return: below average bond funds’ risk level: no bond funds bond funds’ return: no bond funds

equity management: value-oriented with an emphasis on fundamentals

FIRST INVESTORS [800.423.4026] inception: 1930 number of funds: 38 total assets: $75 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: above average bond funds’ risk level: above average bond funds’ return: above average

equity management: conservative bottom-up approach; first to offer an insured tax-free fund

FPA [800.982.4372] inception: 1978 number of funds: 6 total assets: $8 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: very low bond funds’ return: very low

equity management: value contrarian approach with an emphasis toward small caps; initially an advisory firm in 1953

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3.16

FRANKLIN TEMPLETON [800.632.2350] inception: 1954 number of funds: 97 total assets: $575 billion ownership costs: low

stock funds’ risk level: below average stock funds’ return: below average bond funds’ risk level: average bond funds’ return: below average

equity management: bottom-up with target-selling prices; well-known fixed-income funds but has special talents in foreign and value securities

GABELLI [800.422.3554] inception: 1977 number of funds: 28 total assets: $29 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: average bond funds’ return: high

equity management: fundamental Graham and Dodd approach

GOLDMAN SACHS [800.292.4726] inception: 1869 number of funds: 44 total assets: $5.8 trillion ownership costs: average

stock funds’ risk level: average stock funds’ return: below average bond funds’ risk level: low bond funds’ return: average

equity management: growth and value plus value offerings using proprietary models; offices in 22 countries

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MUTUAL FUNDS

HARBOR [800.422.1050] inception: 1983 number of funds: 14 total assets: $37 billion ownership costs: very low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: average bond funds’ return: low

equity management: star manager used; value and growth equity options

HARTFORD [800.843.7824] inception: 1810 number of funds: 53 total assets: $300 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: above average bond funds’ return: average

equity management: growth at a reasonable price (GARP); leading seller of annuities that originally started as a fire insurance co. in 1810

HERITAGE [800.421.4184] inception: 1985 number of funds: 9 total assets: $10 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: high bond funds’ return: low

equity management: relies on multiple advisory services

HIGHMARK [800.433.6884] inception: 1987 number of funds: 18 total assets: $8 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: below average bond funds’ risk level: below average bond funds’ return: high

equity management: single fund managers offer growth and value plays

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3.18

HUNTINGTON [800.253.0412] inception: 1987 number of funds: 16 total assets: $2 billion ownership costs: low

stock funds’ risk level: low stock funds’ return: average bond funds’ risk level: low bond funds’ return: above average

equity management: managers each average 20 years experience

ING [800.992.0180] inception: 1990 number of funds: 178 total assets: $440 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: above average bond funds’ risk level: average bond funds’ return: average

equity management: growth and value choices plus sector funds

IXIS [800.633.3330] inception: 1968 number of funds: 22 total assets: $12 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: above average bond funds’ return: below average

equity management: top-down and/or bottom up

JANUS [800.525.3713] inception: 1969 number of funds: 58 total assets: $170 billion ownership costs: very low

stock funds’ risk level: average stock funds’ return: above average bond funds’ risk level: average bond funds’ return: above average

equity management: bottom-up fundamental approach

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3.19

MUTUAL FUNDS

JENNISONDRYDEN [800.225.1852] inception: 1927 number of funds: 52 total assets: $60 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: average bond funds’ return: high

equity management: bottom-up growth-style investing

JOHN HANCOCK [800.257.3336] inception: 1862 number of funds: 53 total assets: $525 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: above average bond funds’ risk level: above average bond funds’ return: above average

equity management: fundamental bottom-up undervalued approach

JPMORGAN [800.480.4111] inception: n/a number of funds: 95 total assets: $275 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: below average bond funds’ risk level: average bond funds’ return: above average

equity management: top-down and bottom up; 700 researchers in 14 countries

LAZARD [800.823.6300] inception: 1856 number of funds: 12 total assets: $5 billion ownership costs: very low

stock funds’ risk level: average stock funds’ return: below average bond funds’ risk level: high bond funds’ return: high

equity management: undervalued bottom-up approach; formed over 150 years ago as a banking concern

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MUTUAL FUNDS

3.20

LEGG MASON [800.822.5544] inception: 1962 number of funds: 92 total assets: $930 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: above average bond funds’ risk level: average bond funds’ return: average

equity management: concentration on value investing

LORD ABBETT [800.821.5129] inception: 1929 number of funds: 28 total assets: $48 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: above average bond funds’ return: average

equity management: value-oriented using quantitative screening

MAINSTAY [800.624.6782] inception: 1854 number of funds: 43 total assets: $250 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: high bond funds’ return: average

equity management: includes value and growth offerings; began as New York Life Insurance in 1854

MANAGERS [800.835.3879] inception: 1983 number of funds: 32 total assets: $6 billion ownership costs: low

stock funds’ risk level: above average stock funds’ return: average bond funds’ risk level: high bond funds’ return: average

equity management: multi-manager approach using different investment styles

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3.21

MUTUAL FUNDS

MERIDIAN [800.446.6662] inception: 1977 number of funds: 3 total assets: $270 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: below average bond funds’ risk level: no bond funds bond funds’ return: no bond funds

equity management: value-oriented bottom-up approach

MFS [800.343.2829] inception: 1924 number of funds: 67 total assets: $200 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: average bond funds’ return: average

equity management: bottom-up fundamental analysis; MIT is the oldest mutual fund in the country

MORGAN STANLEY [800.869.6397] inception: 195 number of funds: 67 total assets: $55 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: below average bond funds’ risk level: average bond funds’ return: below average

equity management: multi-manager strategy

MOSAIC [800.336.3063] inception: 1973 number of funds: 8 total assets: $1 billion ownership costs: low

stock funds’ risk level: low stock funds’ return: below average bond funds’ risk level: average bond funds’ return: high

equity management: highly-concentrated portfolios using fundamental analysis

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3.22

MUNDER [800.468.6337] inception: 1985 number of funds: 18 total assets: $12 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: average bond funds’ return: high

equity management: fundamental quantitative and qualitative analysis; offers one of the oldest internet funds

NEUBERGER BERMAN [800.461.1899] inception: 1939 number of funds: 26 total assets: $135 billion ownership costs: very low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: below average bond funds’ return: below average

equity management: bottom-up approach with an emphasis on value stocks; introduced the first no-load value fund

NICHOLAS [800.544.6547] inception: 1967 number of funds: 6 total assets: $4 billion ownership costs: very low

stock funds’ risk level: below average stock funds’ return: average bond funds’ risk level: high bond funds’ return: low

equity management: low turnover with blended investment approach

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3.23

MUTUAL FUNDS

NORTHERN [800.595.9111] inception: 1994 number of funds: 45 total assets: $15 billion ownership costs: very low

stock funds’ risk level: average stock funds’ return: above average bond funds’ risk level: average bond funds’ return: average

equity management: growth and value using top-down and bottom-up

NUVEEN [800.257.8787] inception: 1961 number of funds: 46 total assets: $18 billion ownership costs: low

stock funds’ risk level: below average stock funds’ return: below average bond funds’ risk level: above average bond funds’ return: below average

equity management: pioneer in tax-free bonds; added large- and mid-cap growth and values stocks in 1996; started as an investment bank in 1898

OAK ASSOCIATES [888.462.5386] inception: 1985 number of funds: 8 total assets: $1 billion ownership costs: low

stock funds’ risk level: high stock funds’ return: high bond funds’ risk level: no bond funds bond funds’ return: no bond funds

equity management: qualitative, fundamental, and volatile

OAKMARK [800.625.6275] inception: 1869 number of funds: 7 total assets: $38 billion ownership costs: low

stock funds’ risk level: low stock funds’ return: below average bond funds’ risk level: below average bond funds’ return: below average

equity management: bottom-up value-based stock selection

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3.24

OLD MUTUAL ADVISOR II [800.433.0051] inception: 2005 number of funds: 17 total assets: $3 billion ownership costs: low

stock funds’ risk level: above average stock funds’ return: above average bond funds’ risk level: low bond funds’ return: above average

equity management: aggressive growth; formally PBHG—a seasoned fund group

OPPENHEIMER [800.225.5677] inception: 1960 number of funds: 91 total assets: $240 billion ownership costs: average

stock funds’ risk level: above average stock funds’ return: average bond funds’ risk level: high bond funds’ return: average

equity management: fundamental and quantitative analysis

PAYDEN & RYGEL [800.572.9336] inception: 1983 number of funds: 19 total assets: $4 billion ownership costs: very low

stock funds’ risk level: high stock funds’ return: above average bond funds’ risk level: average bond funds’ return: average

equity management: team decisions

PHOENIX [800.403.5000] inception: n/a number of funds: 53 total assets: $575 billion ownership costs: average

stock funds’ risk level: above average stock funds’ return: average bond funds’ risk level: above average bond funds’ return: average

equity management: each fund is managed with a distinct approach

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3.25

MUTUAL FUNDS

PIMCO [800.927.4648] inception: 1971 number of funds: 50 total assets: $675 billion ownership costs: very low

stock funds’ risk level: average stock funds’ return: below average bond funds’ risk level: below average bond funds’ return: average

equity management: varies by fund—group is known for savvy bond manager; company is now owned by insurance giant, Allianz

PIONEER INVESTMENTS [800.225.6292] inception: 1928 number of funds: 47 total assets: $42 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: below average bond funds’ risk level: above average bond funds’ return: below average

equity management: emphasis on value with solid fundamentals

PRINCIPAL FINANCIAL GROUP [800.247.4123] inception: 1969 number of funds: 31 total assets: $13 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: below average bond funds’ risk level: average bond funds’ return: average

equity management: value orientation using bottom-up

PUTNAM INVESTMENTS [800.225.1581] inception: 1937 number of funds: 67 total assets: $210 billion ownership costs: average

stock funds’ risk level: below average stock funds’ return: average bond funds’ risk level: high bond funds’ return: high

equity management: team decisions with oversight by risk-management committee

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3.26

RIVERSOURCE INVESTMENTS [800.862.7919] inception: 1940 number of funds: 74 total assets: $80 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: above average bond funds’ return: high

equity management: growth and value; owned by American Express

RS [800.766.3863] inception: 1986 number of funds: 22 total assets: $11 billion ownership costs: low

stock funds’ risk level: high stock funds’ return: above average bond funds’ risk level: no bond funds bond funds’ return: no bond funds

equity management: specializes in small and mid cap stocks

SCHWAB [800.855.9102] inception: 1991 number of funds: 42 total assets: $47 billion ownership costs: very low

stock funds’ risk level: below average stock funds’ return: below average bond funds’ risk level: low bond funds’ return: average

equity management: indexing strategy; some with a value slant

SELIGMAN GROUP [800.221.2783] inception: 1929 number of funds: 43 total assets: $9 billion ownership costs: average

stock funds’ risk level: above average stock funds’ return: above average bond funds’ risk level: average bond funds’ return: high

equity management: growth and value offerings; company dates back to 1864

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3.27

MUTUAL FUNDS

SSGA [800.647.7327] inception: 1978 number of funds: 21 total assets: $8 billion ownership costs: low

stock funds’ risk level: below average stock funds’ return: average bond funds’ risk level: below average bond funds’ return: average

equity management: conservative fundamental approach

STI CLASSIC [877.984.7321] inception: 1992 number of funds: 43 total assets: $18 billion ownership costs: low

stock funds’ risk level: below average stock funds’ return: average bond funds’ risk level: average bond funds’ return: above average

equity management: growth and value

SUNAMERICA GROUP [800.858.8850] inception: 1971 number of funds: 33 total assets: $10 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: above average bond funds’ risk level: above average bond funds’ return: above average

equity management: technical and fundamental; also offers annuities

T. ROWE PRICE [800.638.5660] inception: 1937 number of funds: 83 total assets: $160 billion ownership costs: very low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: above average bond funds’ return: below average

equity management: fundamental bottom-up approach

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3.28

TAMARACK [800.422.2766] inception: 1985 number of funds: 10 total assets: $33 billion ownership costs: low

stock funds’ risk level: above average stock funds’ return: above average bond funds’ risk level: high bond funds’ return: high

equity management: emphasis on small- and mid-cap stocks

THIRD AVENUE [800.443.1021] inception: 1986 number of funds: 4 total assets: $18 billion ownership costs: low

stock funds’ risk level: below average stock funds’ return: low bond funds’ risk level: no bond funds bond funds’ return: no bond funds

equity management: fundamental approach to ―safe and cheap‖ stocks

THORNBURG [800.847.0200] inception: n/a number of funds: 12 total assets: $21 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: low bond funds’ risk level: low bond funds’ return: average

equity management: fundamental approach

THRIVENT [800.847.4836] inception: 2001 number of funds: 36 total assets: $800 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: low bond funds’ return: below average

equity management: growth and value choices; formerly Lutheran Brotherhood and AAL—seasoned fund groups

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3.29

MUTUAL FUNDS

TIAA-CREF [800.842.2252] inception: 2002 number of funds: 22 total assets: $450 billion ownership costs: very low

stock funds’ risk level: average stock funds’ return: below average bond funds’ risk level: average bond funds’ return: average

equity management: active and passive; has overseen annuities assets for decades

TOUCHSTONE [800.543.0407] inception: 1974 number of funds: 13 total assets: $8 billion ownership costs: average

stock funds’ risk level: above average stock funds’ return: high bond funds’ risk level: high bond funds’ return: above average

equity management: growth and value

U. S. GLOBAL INVESTORS [800.873.8637] inception: 1968 number of funds: 11 total assets: $2.2 trillion ownership costs: low

stock funds’ risk level: high stock funds’ return: high bond funds’ risk level: low bond funds’ return: below average

equity management: growth and value team approach

USAA GROUP [800.531.8181] inception: 1970 number of funds: 29 total assets: $41 billion ownership costs: very low

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: average bond funds’ return: low

equity management: bottom-up blend

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3.30

VAN ECK [800.221.2220] inception: 1955 number of funds: 4 total assets: $1.4 billion ownership costs: average

stock funds’ risk level: high stock funds’ return: average bond funds’ risk level: no bond funds bond funds’ return: no bond funds

equity management: the first gold fund plus offers a mid-cap value fund

VAN KAMPEN [800.421.5666] inception: 1994 number of funds: 43 total assets: $85 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: average bond funds’ return: average

equity management: bias toward large cap stocks; also offers UITs and closed-end funds

VANGUARD [800.662.7447] inception: 1975 number of funds: 107 total assets: $1.2 trillion ownership costs: very low

stock funds’ risk level: average stock funds’ return: below average bond funds’ risk level: above average bond funds’ return: average

equity management: top-down and bottom-up; pioneer of index funds

VICTORY [800.539.3863] inception: 1994 number of funds: 13 total assets: $65 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: below average bond funds’ risk level: average bond funds’ return: above average

equity management: flexible value style with large cap bias

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3.31

MUTUAL FUNDS

WADDELL & REED [800.923.3355] inception: 1940 number of funds: 51 total assets: $37 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: below average bond funds’ return: average

equity management: growth-oriented top-down approach

WASTACH [800.551.1700] inception: 1975 number of funds: 12 total assets: $6 billion ownership costs: low

stock funds’ risk level: high stock funds’ return: above average bond funds’ risk level: high bond funds’ return: above average

equity management: emphasis on small- and mid-cap stocks

WEISS, PECK & GREEN [800.223.3332] inception: 1971 number of funds: 9 total assets: $21 billion ownership costs: very low

stock funds’ risk level: n/a stock funds’ return: n/a bond funds’ risk level: above average bond funds’ return: high

equity management: emphasis on cash flow and small-cap value

WEITZ SERIES [800.304.9745] inception: 1983 number of funds: 8 total assets: $7 billion ownership costs: very low

stock funds’ risk level: low stock funds’ return: low bond funds’ risk level: low bond funds’ return: below average

equity management: discount value

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3.32

WELLS FARGO [800.222.8222] inception: 1991 number of funds: 94 total assets: $640 billion ownership costs: low

stock funds’ risk level: average stock funds’ return: above average bond funds’ risk level: below average bond funds’ return: below average

equity management: bottom-up approach; parent company dates back to 1852

WM [800.222.5852] inception: 1939 number of funds: 23 total assets: $30 billion ownership costs: average

stock funds’ risk level: average stock funds’ return: average bond funds’ risk level: average bond funds’ return: average

equity management: focus on small- and mid-cap stocks; well-known for its ―funds of funds‖

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4.1

4.ETF

ETFS AND CTFS

INDUSTRY STATISTICS

By the middle of 2007, there were 500 ETFs whose total market capitalization was about $475 billion. The expense ratios for ETFs vary quite a bit. Typically, the lowest cost ETFs are those that cover broad, well-known U.S. stock market indexes (e.g., Vanguard’s Total Market ETF charges 0.07% annually, or $7 for every $10,000 invested). The average expense ratio for a U.S. stock ETF has gone from 0.43% to 0.52% from the first to second quarter of 2007; the increase is due to new specialized offerings that have comparatively high expense ratios. Advisors can compare expenses for ETFs and mutual funds using actual dollar figures by using the expense-analyzer tool at www.nasd.com, the National Association of Securities Dealers’ web site.

A fund’s expense ratio does not include commission costs or the bid-ask spread; the greater the turnover rate, the more these ―hidden costs‖ affect returns.

Sometimes, these spreads can equal or exceed the ETF’s expense ratio (e.g., First Trust DB Strategic Value Index). At the other end of the spectrum are SPDRs, whose average bid-ask is less than 0.01%. The average bid-ask spread for each ETF can be obtained (for free) by going to the web site, xtf.com.

Another web site, IndexUniverse.com, is an index-industry web site that does ETF analysis, including tracking error (how close does the ETF track its underlying index). The average tracking error among U.S. major-market ETFs was 0.3% in 2006, up from 0.2% in 2005, according to Morgan Stanley.

In its study of major ETF providers’ tracking error for 2006, Morgan Stanley found that Vanguard had the lowest average annual fees and the lowest average tracking error, 0.28%. Vanguard’s Small Cap Growth ETF had a tracking error of just 0.01%. PowerShares ETFs had the highest average fees and also the highest average tracking error, 0.7%.

UTILITY AND BOND ETFS Through the first quarter of 2007, the Utilities Select Sector SPDR (XLU), which mirrors utility stocks inside the S&P 500, delivered five-year annualized gains of 11.2%. Historically, investors have been attracted to utilities because of their stability and dividends. During the first half of 2007, utilities had a projected dividend of 2.9%, versus 4.7% for 10-year Treasuries. Utility sector SPDRs have a p/e ratio of 16, close to that of the S&P 500.

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4.2

In April 2007, Vanguard launched four ETFs (0.11% expense ratios) that track Lehman Brothers bond indices: Vanguard Total Bond Market (BND), Vanguard Short-Term Bond (BSV), Vanguard Intermediate-Term Bond (BIV), and Vanguard Long-Term Bond (BLV). In 1986, Vanguard introduced the first mutual fund bond index for individual investors.

INDEX FUNDS OUTPERFORM ETFS According to a May 7th, 2007 article in The Wall Street Journal, big, low-cost index mutual funds often outperform their ETF counterparts. The study looked at some of the biggest and best-known ETFs and mutual funds in four different categories: the S&P 500, the total U.S. stock market, international stock markets, and a broad-based U.S. bond index.

The margins of victory for the top performers in each of the four categories were about 0.05% (or $5 on a $10,000 investment). Moreover, the analysis did not take into account any commissions paid to buy the ETFs. Looking at different periods from 1997 through the first quarter of 2007, index mutual funds prevailed 34 of the 40 time periods; the funds were always the winner when comparing after-tax returns for one-, three-, and 10-year after-tax categories. ETFs sold by Barclays and State Street usually beat the average performance of index funds in their respective categories—but so did the big, low cost index funds.

According to Jim Wiandt, editor of the Journal of Indexes, an index-investment industry publication, investors ―should consider an index fund’s philosophy and execution more than whether the fund is an ETF.‖ In theory, an index fund should trail its benchmark by at least the amount of its expense ratio. Fund managers can reduce some of the costs by techniques such as lending out the fund’s underlying securities and buying stocks ahead of anticipated additions to their index.

BOND ETFS Advisors interested in bond ETFs may want to check out some new offerings: Barclays Global Investors (recently added 10 debt ETFs), Vanguard, Ameristock, State Street, and Bear Sterns. As of the middle of 2007, no ETFs tracked municipal bonds.

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4.3

ETFS AND CTFS

BUY-WRITE STRATEGY The iPath CBOE S&P 500 BuyWrite Index ETN tracks the S&P 500 and systematically sells covered call options on the index. The covered call strategy, sometimes referred to as a ―buy-write strategy,‖ can enhance a portfolio’s return and reduce risk. The underlying portfolio, the S&P 500 in this case, has limited upside potential since appreciation past a certain level means the securities will be called away.

Barclays Bank, which oversees all ETF ―iShares,‖ has an expense ratio of 0.75%, versus 1.20% for two closed-end funds offered by Eaton Vance that utilize the same strategy. The buy-write ETN is similar to an exchange-traded fund (ETF) except it is a senior, unsecured, unsubordinated debt security linked to the performance of an index. Because the Barclays ETN continuously sells covered calls, it is expected to have returns that have little correlation to the U.S. stock market.

CLOSED-END FUNDS Typically, closed-end funds (CEFs) trade at about a 4% discount to NAV; the discount has widened to 6.5% as of August 20th, 2007 due liquidity and quality concerns in the debt marketplace. According to CEF expert Thomas Herzfeld, ―small closed-end funds selling at a large NAV discount generally don’t have long lives ahead of them‖ (meaning it is likely that the fund’s shareholders will vote to change the fund into an open-end fund and thereby have an immediate profit—the difference between the discount and NAV).

Some CEFs to consider include: Lazard Global Total Return & Income Fund (a stock and foreign currency portfolio trading at a 12% discount), Morgan Stanley Global Opportunity Bond Fund (down 39% since its February 2007 peak and trading at a 10% NAV discount), Black Rock California Investment Quality Municipal Trust (7% discount and trading at 24% less than its February 2007 peak), and Morgan Stanley Quality Municipal Securities (taxable equivalent yield of 8% for investors in a 35% federal tax bracket).

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QUARTERLY UPDATES COLLEGE EDUCATION

5.1

5.KIDDIE

COLLEGE EDUCATION

TAX EXTENDED

Beginning in 2008, the new age limit for the ―Kiddie Tax‖ is increased from age 17 to children who are under age 18, or under 24 if the child is a full-time student.

The provision will not apply to some children with paid jobs. Furthermore, the new law applies only to children ―whose earned income does not exceed one-half of the amount of their support.‖ Investment income, sometimes referred to as ―unearned income,‖ above a certain level ($1,700 for 2007), is subject to the parents’ tax rates.

COLLEGE FINANCIAL AID Average college tuition and fees at private colleges rose to $22,218 for the 20062007 school year, a 6% increase from the previous year, according to The Wall Street Journal. Add room and board and the total cost averages $30,367. In May 2007, Education Secretary Margaret Spelling commented that the student-aid system she oversees is ―redundant, Byzantine, and broken.‖ There are two different systems of federal student-loan distribution. Whether your clients use banks for these loans or borrow directly from the federal government depends entirely on the college attended. Additionally, there is confusion associated with the different tax-advantaged college-savings vehicles—Roth IRAs, 529 plans, and Coverdell Education Savings Accounts. On top of all this are the varied ways your clients finances are considered, ranging from the U.S. Department of Education’s assessment for federal financial-aid purposes to a school’s use of their own formula to figure out how to distribute their own financial aid.

Defining Financial Aid In addition to scholarships and grants, there are different types of loans available.

The most common student loan is the Stafford loan. The annual limits for students who are considered ―dependents‖ is $3,500 for freshmen and $4,500 for sophomores; juniors and seniors can borrow up to $5,000 a year.

Stafford loans are only available to those who fill out a Fafsa form (Free Application for Federal Student Aid). The unsubsidized variety of these loans does not require the student to demonstrate need. As of the middle of 2007, the interest rate on Stafford loans was a maximum of 6.8%. As a side note, the rate on loans from private lenders is not capped and was about 10% during the same period.

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COLLEGE EDUCATION

5.2

Another advantage of a federal student loan (such as Stafford loans) is that they provide more repayment flexibility than what is afforded by a private lender. For example, a borrower who became unemployed (economic hardship) could receive a deferment. In the case of a deferment, some loans continue to accrue interest while other loans have the government pay such interest during the economic hardship period.

Besides Stafford, another type of federal loan is PLUS. Unlike Stafford loans, Plus loans have no pre-set limit. However, the total amount borrowed cannot exceed the cost of attendance minus other forms of aid received. As of the middle of 2007, the maximum rate for a PLUS loan was 8.5%. The federal government expects repayment of a PLUS loan from the parent (the borrower) and not the student.

Formula Used For Qualification In order to qualify for a federal loan, certain assets are excluded from the formula.

In addition to a personal residence and retirement plans, the borrower is granted an ―asset protection allowance‖ which varies based on age; for the typical parent, the figure is roughly $50,000. A number of private colleges use a different formula which excludes retirement accounts but caps the net home equity at 2-3 times annual income.

Getting A Second Opinion Many people rely on their college’s financial-aid office to provide them with objective information on loans and to make specific recommendations. During the past few years, investigations by Congress have shown that such recommendations are not always the best and not always objective. For this reason, your clients should do some comparison shopping (e.g., Citigroup, Nelnet, Northstar Education Finance, MyRichUncle).

Two College Students Federal assessment for aid eligibility is based on the parents’ total expected contribution. Thus, parents with two or more children in college at the same time are likely to qualify for more financial aid.

Special Circumstances The Higher Education Act, which authorizes federal aid programs, gives college aid officers the ability to make adjustments when warranted. If you have a client whose circumstances are special, recommend that they complete a ―Professional Judgment Review‖ letter.

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5.3

COLLEGE EDUCATION

A Dose Of Reality Close to 90% of parents believe that their college-bound children will receive a scholarship or grant. An independent study shows that 92% of parents overestimate the amount of such grants and scholarships. Web sites such as fastweb.com and collegeboard.com match student profiles to scholarship opportunities.

Ranking 529 Plans All 50 states and the District of Columbia offer their own 529 plan. Some state plans include a tax break for state residents. In addition to possibly receiving a state income tax break, your clients should be advised to compare fees. Experts generally agree that annual 529 plan fees should be no more than 1.5% of the amount in the plan. The Utah Educational Savings Plan, the Maryland College Investment Plan, and the College Savings Plan of Nebraska have been cited as having very low fees and very good performance.

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QUARTERLY UPDATES HEALTH CARE

6.1

6.HEALTH

HEALTH CARE

CARE PREMIUMS DOUBLE

For 2007, health care insurance premiums increased 6% from 2006 prices. The annual cost for family coverage through an employer plan is now more than $12,000, a figure greater than what a minimum-wage worker earns in a year.

The average worker now pays $3,281 a year to cover his portion of the health insurance premium; double what workers paid in 2000. Since the beginning of 2000 to the beginning of 2007, wages and inflation have both increased by roughly 20%, versus an 80% increase for health insurance, according to the Kaiser Family Foundation’s annual survey.

MEDICAID PLANNING UPDATE Rules for qualifying for Medicaid long-term care were tightened in 2006; as of the middle of 2007, some states are still in the process of implemented the new regulations. The 2006 rules make it harder for someone to make gifts and still qualify for Medicaid benefits (e.g., the ―look-back‖ period was extended from three to five years—see below).

In the past, individuals generally became eligible for Medicaid assistance to pay for long-term care after using up a certain amount of assets. The remaining amount varies from state to state, but it is as little as $2,000 in cash and investments. This meant that a Medicaid applicant with a $50,000 bank account and $130,000 brokerage account would have to ―spend down‖ (i.e., use assets to pay for medical care or other expenses) up to $178,000 of the $180,000 combined accounts. Such spend downs mean that there would be little to pass on to heirs.

A strategy used in the past was to make gifts of assets to heirs such as children and grandchildren before entering a nursing home. Such a gift-giving program meant that assets stayed ―in the family‖—but at a cost. For example if the nursing home applicant gave away the equivalent of 16 months of hospital payments within three years of entering the nursing home, he or she would not qualify for Medicaid for 16 months. The new rules extend the number of years from three to five. This is what is referred to as ―look-back‖ period. Today, there are only a few strategies available to shelter assets for prospective Medicaid applicants.

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HEALTH CARE

6.2

One strategy is to set up an irrevocable income-only trust and retitling the ownership of the house from an individual (or couple) into the name of the irrevocable trust. Such an arrangement would allow the parent(s) to still live in the house and even sell it.

A second strategy is to have your client purchase a long-term care policy that will cover any look-back period (which ranges from 1-60 months). Such an insurance policy would only be beneficial if the client were to enter a nursing home, had spent down his or her assets to the state’s minimum requirements, and gifts had been made within five years of entering the nursing home.

A third strategy that is still available is the purchase of an immediate annuity, thus changing something that would have been an asset (and possibly spent down) into an income stream only. The immediate annuity provides an income stream to the healthy spouse while still allowing Medicaid eligibility for the other spouse. In order for the annuity strategy to work, two requirements must be fulfilled. First, the beneficiary of the annuity must be named the beneficiary of the contract.

Second, the income stream cannot be deferred (it must begin immediately) and the payments must be at least somewhat uniform.

MEDICARE PART B PREMIUMS As of the beginning of 2007, higher-income retirees began paying more for Medicare Part B, which covers doctor visits and outpatient care. The standard monthly premium for 2007 was $93.50; because of their income, some people were paying as much as $161.40 per month. It has been estimated that about 4% of Medicare beneficiaries are now paying more than the standard premium.

Part B premiums are based on ―modified adjusted gross income‖ (MAGI), which is a combination of AGI, tax-exempt interest, and tax filing status. For example, premiums are $105.890 a month for individuals with a MAGI from $80,001 to $100,000 or a married couple filing a joint return with a MAGI from $160,001 to $200,000.

The ―initial enrollment period‖ for Medicare Part B starts three months before the applicant turns 65 and lasts for seven months. If signup does not occur during this period, the applicant must wait for the ―general enrollment period‖ which lasts from January 1st through March 31st every year; coverage then begins the following July 1st. Premiums can go up 10% for every 12 months of eligibility that pass before signup.

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6.3

HEALTH CARE

The 10% annual premium increase can be avoided if either spouse is still working and has health coverage through their employer. In such a case, the employee can sign up for Part B anytime while still covered by the employer’s insurance or up to eight months after employment is terminated or coverage ends, whatever comes first. If application has not been made during such period, the person has to wait until the next general enrollment period (see Social Security publication 10161 and 10162).

UNIVERSAL HEALTH CARE COVERAGE Public support for universal health care coverage has increased, due to greater awareness and increased costs. Per capita health care costs are $7,500 for 2007, an $800 increase from 2005. The number of uninsured has grown from 37 million in 1993 to 45 million today. The cost of health care for the uninsured are simply passed on to taxpayers and those with coverage. In 2005, those with insurance paid a ―hidden tax‖ of over $920 on their insurance premiums, according to Families USA, a consumer advocacy group.

Texas leads the nation with the highest rage of uninsured (27%), followed by Florida (24%), New Mexico (24%), and Oklahoma (22%). Those between the ages of 19-24 are the most likely to be uninsured; they represent 13% of the insured and 24% of the uninsured population. In 1940, 10% of employees received health insurance from their employer. By 1950, that number had risen to 50%.

The U.S. spent 15.3% of its GDP on health care in 2004; other industrialized nations spent an average of 8.6%, according to the Organization for Economic Cooperation and Development. The U.S. ranks 29th in overall life expectancy (78 years). According to the Center for American Progress, Medicare costs could be reduced by $1 trillion over the next 25 years if obesity among seniors could be returned to 1980s levels. The American Public Health Association says chronic illness (obesity, heart disease, diabetes, etc.) account for 75% of health costs.

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6.4

SPOUSAL MEDICAL COVERAGE One of the biggest financial challenges for those about to retire is the transition from private to federal health insurance. The first place to seek help is the retiring spouseâ&#x20AC;&#x2122;s employer. A number of companies provide coverage for the spouse. The uncovered spouse may have to pay up to 100% of any premiums. Large employers may also provide free health insurance counseling.

The next place to seek help is the State Health Insurance Assistance Program (SHIP). This agency has counselors in every state that provide free one-on-one help (phone 800-434-0222). There is a national directory of SHIP contacts at medicare.gov/contacts/static/ allStateContacts.asp. Another site, caremanager.org, offers geriatric-care managers who can help your clients sort through the different coverage options.

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7.1

7.2006

ANNUITIES

ANNUITY SALES

For the 2006 calendar year, fixed-rate annuity sales totaled $76 billion ($5.5 billion of which was EIA sales), down 5% from the previous year. Variable annuity sales totaled $161 billion. The combined sales for both fixed-rate and variable, approximately $237 billion, was a record high, according the LIMRA International.

LIVING BENEFITS INCREASE SALES For the 2006 calendar year, two-thirds of all variable annuity sales included a living benefit rider, up from 50% of sales in 2004. The cost of a living benefit, which can protect an investor from market declines and/or guarantee minimum rates of return while still enjoying the upside potential of the markets, ranges from 0.15% to %1.10, according to The Wall Street Journal. The typical living benefit costs %0.60 per year. Once the rider is opted for, few insurers allow the contract owner to later cancel the benefit.

The annual costs of a variable annuity without a living benefit generally range from 0.7% to over 2.0%. Once a living benefit is added, the total costs frequently range from 2.5% to 3.2% each year. Certain enhanced death benefits and/or upfront bonuses can drive up the price another 0.1% to 0.4% per year. Advisors need to be conscious of the total costs when counseling a client or prospect.

One approach would be to tell the client that he has all of the upside potential of the stock market, minus about 3% a year, but none of the downside risk. As costly as this may seem, it is equally important to point out that without a living benefit, the client would not be able to have such a high equity exposure, given his or her risk level. The additional equity returns could easily offset the returns the older or conservative client would have experienced in fixed income.

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7.2

There are three basic types of living benefits: (1) guaranteed minimum income (assures future income at a minimum level—typically based on the living benefit value and not the contract value); (2) guaranteed minimum withdrawal (withdraw a certain percentage of the investment each year); and (3) guaranteed accumulation (you cannot sustain living benefit losses if the market drops—you can only experience gains and/or a set return). The most popular living benefit is the guaranteed minimum withdrawal. Under this benefit, investors are usually offered a guaranteed withdrawal over a set period (4-7% per year) and/or over their remaining lifetime.

There are three costs to a living benefit. First, the cost of the rider. Second, limitations as to how money is taken out if the benefit is used. Third, the investment choices are frequently limited to asset allocation models that have 80% or less exposure to equities. Two ―non-believers‖ in living benefits are Northwestern Mutual Life Insurance (the company says ―a well-structured financial plan can provide the same benefits the riders do‖) and the variable annuity expert at Morningstar, Frank O’Connor (―allocate your assets properly and have realistic expectations fro withdrawals, and you won’t need this benefit‖).

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8.1

RETIREMENT PLANNING

8.ADVISOR

INFO FROM SOCIAL SECURITY

The web site, socialsecurity.gov/financial planners, links advisors to resources about retirement, disability, taxation of Social Security benefits, and theft of a Social Security number. Social Security spokespersons believe that this is an excellent, â&#x20AC;&#x2022;one-stop-shopping portal for financial advisors and their clients that are interested in retirement planning.â&#x20AC;&#x2013; The web site contains a number of calculators for determining retirement eligibility and the best time to start receiving retirement and other benefits.

2007 SOCIAL SECURITY UPDATE By law, Social Security taxes and benefits change each year. Whether your clients are working or receiving benefits, these changes are important for the advisor to know. The information below is divided into three tables: people who are working, people who receive benefits, and people on Medicare.

People Who Are Working Social Security Taxes

2007

Employer / employee (each)

6.2% on earnings up to $97,500

Self-employed

12.4% on earnings up to $97,500 *

Medicare Taxes Employer / employee (each)

1.45% on all earned income

Self-employed

2.9% on all earned income *

* can be partially offset by income tax provisions

People Who Receive Social Security Benefits Status

2007

At full retirement age or older

No limit on earnings

Under full retirement age

$12,960 limit (for every $2

In the year you reach full retirement age

$34,440 limit (for every $3

over the limit, benefits are reduced by $1) over the limit, benefits are reduced by $1 until the month full retirement is reached)

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8.2

People On Medicare Hospital Insurance [Part A]

2007

st

1 60 days in a hospital, patient pays

$992

Days 61 through 90, patient pays

$248 per day

Beyond 90 days in a hospital, patient pays (for to 60 more days)

up

$496 per day

1st 20 days in a skilled nursing facility, patient pays

$0

Days 21 through 100, patient pays

$124 per day

Medical Insurance [Part B] Premium

$93.50 per month *

Deductible

$131 per year **

* Some people with higher incomes pay higher premiums. ** After the deductible, $131 for 2007, Part B pays for 80% of covered services.

REQUIRED IRA WITHDRAWALS Investors have two choices when paying taxes on their required IRA or qualified plan distributions: (1) file a quarterly estimated tax payment, or (2) have the custodian withhold taxes from the distribution.

CALCULATING REQUIRED WITHDRAWALS Even though required minimum withdrawals (RMDs) from qualified retirement plans such as a 401(k) is calculated the same way as withdrawals from traditional IRAs, you are not allowed to mix or match between the two. In other words, you cannot add your IRA and 401(k) balances together to determine your required distribution for the year.

You cannot add up different 401(k) account balances together (unlike traditional IRA accounts). Thus, even if you take out â&#x20AC;&#x2022;extraâ&#x20AC;&#x2013; from a 401(k), it will not count toward the RMD from your IRA. Someone who is still working and has a 401(k) can delay taking money out until April 1st following the year of retirement (vs. 70 1/2 for traditional IRAs and most qualified plans).

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RETIREMENT PLANNING

To calculate the amount of an RMD, divide the account balance as of the end of the previous year by the number supplied for your age in IRS Publication 590 (Uniform Lifetime Table). If the spouse is more than 10 years younger and is also the sole beneficiary of the account for the entire year, the divisor used can be found in the same publication under the heading, ―Joint Life and Last Survivor Expectancy Table.‖

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9.1

FOREIGN SECURITIES

9.WORLD STOCK

MARKET WEIGHTINGS

As of the end of the first half of 2007, U.S. markets continued to dominate the rest of the stock markets around the world, according to JP Morgan, FactSet, MSCI, and Standard & Poor’s―Emerging‖ is comprised of Korea, Brazil, Russia, India, China (each is 1%) and other (4%); ―Europe‖ is comprised of France (5%), Germany (4%), Switzerland (3%), Spain (2%), and other (6%). As of the beginning of 2007, total global stock market capitalization was $31 trillion.

Weights in MSCI All Country World Index U.S.

44%

Emerging

9%

Europe

20%

Pacific

4%

U.K.

10%

Canada

3%

Japan

10%

Total

100%

WORLD ECONOMICS The table below shows a number of economic figures as of the middle of 2007 for 10 different countries (sources: JP Morgan, EcoWin, and CIA).

World Economics Country U.S.

GDP ($ t) $13.1

GDP Per Capital $44,000

GDP Growth 1%

Unemployment Rate 5%

Canada

1.8

35,600

4

6

Japan

4.2

33,100

3

4

Germany

2.6

31,900

2

9

U.K.

1.9

31,800

3

6

France

1.9

31,100

2

8

Italy

1.8

30,200

1

6

Mexico

1.1

10,700

3

3

China

10.2

7,700

11

4

India

4.2

3,800

9

8

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9.2

WORLD DEMOGRAPHICS The table below shows a number of demographic figures as of the middle of 2007 for 10 different countries (sources: JP Morgan, EcoWin, and CIA).

World Economics Country U.S.

Population (mm) 301

Population Growth 0.9%

% Age > 65 13

Median Age 37

Canada

33

0.9

14

39

Japan

127

-0.1

21

44

Germany

82

0.0

20

43

U.K.

61

0.3

16

40

France

64

0.6

16

39

Italy

58

0.0

20

43

Mexico

109

1.2

6

26

China

1,322

0.6

8

33

India

1,130

1.6

5

25

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FOREIGN SECURITIES

FOREIGN OWNERSHIP OF TREASURIES From 1978 to the first half of 2007, the percentage of U.S. Treasuries owned by foreigners has increased from 12% to 52%; there has only been a 1% increase from 2003 to 2007 (from 51% to 52%). Foreign holders of U.S. Treasuries are (numbers shown in parentheses are billions of U.S. dollars; source: U.S. Treasury Dept).

Holders of U.S. Treasuries [April 2007] Country

Percentage

Japan

28% ($615 b)

China

19% ($414 b)

U.K.

6% ($134 b)

OPEC

5% ($112 b)

Brazil

4% ($80 b)

Caribbean

4% ($77 b)

Luxembourg

3% ($62 b)

Taiwan

3% ($59 b)

All others

28% ($613)

PLAYING IT SAFE WITH CHINA As of the beginning of June 2007, stocks on the Shanghai exchange had a p/e ratio of about 50, compared with 18 for the S&P 500. However, such high prices do not affect U.S. investors since only Chinese citizens are allowed to invest in the vast majority of stocks listed on either the Shanghai or Shenzhen exchanges, Chinaâ&#x20AC;&#x2122;s two main financial centers. U.S. investors are generally limited to stocks listed on Hong Kong and elsewhere. Hong Kongâ&#x20AC;&#x2122;s Hang Seng Index is up less than 4% year-to-date (with a p/e of about 16), versus 37% for the Shanghai Composite Index.

Morningstar recommends that investors look to broadly diversified international and emerging market funds that are not vulnerable to volatile events in a single country. According to Morningstar, pure China funds with at least a 10-year history have suffered drops of 15% or more in at least 12 three-month periods.

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9.4

VALUATION OF MAJOR WORLD MARKETS The table below compares valuations of several market indexes (source: FactSheet).

Comparing Values Overseas [1/1/07] Forward P/E Ratio

Price/Book Ratio

Dividend Yield

S&P 500

22

4.6

1.8

MSCI EAFE

18

3.5

2.4

MSCI Europe

16

3.7

2.7

MSCI Emerging Markets

18

4.7

0.4

MSCI Pacific

21

3.0

1.7

MSCI Japan

23

2.4

1.1

Index

20-YEAR STATISTICS [1987-2006] All of the statistics listed below cover the 20-year period from the beginning of 1987 through the end of 2006.

Poor Hedge Against Inflation—Gold has increased from $484.10 an ounce to $636.70 (a 31.5% increase); the cumulative increase in the CPI was 82.6%, 142.4% in the case of three-month U.S. Treasury Bills.

Rising U.S. Trade Deficit—The U.S. trade deficit was $152 billion at the end of 1987 (and got down to $39 billion in 1992); by the end of 2006, it was $764 billion.

U.S. Dollar vs. the Euro—The first full year of the Euro was 1999, when it took one Euro to equal one U.S. Dollar; by the end of 2006, it took 0.76 Euros to equal one dollar—a cumulative decline for the dollar of 24%.

U.S. Dollar vs. the British Pound—In 1987, it took 0.53 British Pounds to equal one U.S. Dollar; by the end of 2006, it took 0.51 Pounds to equal one dollar—a cumulative decline for the dollar of less than 4%.

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FOREIGN SECURITIES

U.S. Dollar vs. the Japanese Yen—In 1987, it took 121.1 Japanese Yen to equal one U.S. Dollar; by the end of 2006, it took 119.2 Yen to equal one dollar—a cumulative decline for the dollar of less than 1.6%.

U.S. Dollar vs. the Swiss Franc—In 1987, it took 1.27 Swiss Francs to equal one U.S. Dollar; by the end of 2006, it took 1.22 Francs to equal one dollar—a cumulative decline for the dollar of less than 4%.

U.S. Dollar vs. the Brazilian Real—The first full year of the Brazilian Real was 1990, when it took 0.0001 Real to equal one U.S. Dollar; by the end of 2006, it took 2.13 Reals to equal one dollar—a cumulative appreciation for the dollar of 10,200%.

Currency trends tend to last several years. For example, the value of a tradeweighted U.S. Dollar dropped over 25% for the eight-year period ending October 1978, appreciated over 50% from October 1978 to March 1985, declined about 40% from March 1985 to April 1995, appreciated roughly 40% from April 1995 to February 2002, and then declined by about 40% from February 2002 to the end of 2006.

FOREIGN REAL ESTATE FUNDS During the first half of 2007, investors poured $6 billion into foreign real estate funds. Some of the companies offering a foreign real estate fund are: Alpine, Charles Schwab, Cohen & Steers, Fidelity, State Street Global Advisors, and WisdomTree Investments. Companies that offer global real estate funds include: AIM, Franklin, ING, Kensington, and Northern Trust. A few of these funds hedge against the U.S. dollar’s fluctuation.

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10.1

10.REVERSE

REAL ESTATE

MORTGAGE UPDATE

A reverse mortgage is something that should be considered by the advisor who has clients who own a residence and are at least 62 years old. The older the client, the greater the loan. Money from a reverse mortgage can be used for anything and can be received by the borrower as a lump sum or as periodic payouts.

A reverse mortgage can be paid off at anytime. The homeowner is never forced to sell the home or make any payments. The loan does become due and payable (principal plus all deferred compounded interest payments) when the owner dies or permanently moves out of the house. In short, a reverse mortgage can provide instant cash for the borrower and nothing ever has to be paid off (unlike a home equity loan)â&#x20AC;&#x201D;as long as the person keeps and lives in the residence.

Historically, homeowners have been turned off by reverse mortgages because of misconceptions and/or the high costs and complexities of obtaining such a loan.

As competition heats up, the costs have started to come down. There are now a large number of companies that deal in reverse mortgages, including: Bank of America, Countrywide Financial, GNMA, IndyMac Bancorp, and Seattle Mortgage.

The Department of Housing and Urban Development (HUD), insures most reverse mortgages, is strongly considering lowering original costs and mortgage insurance premiums. Guarantees by GNMA mean annual rates that are 0.5-0.8% lower.

Roughly 90% of all reverse mortgages are insured by the U.S. Government through a Home Equity Conversion Mortgage (HECM). However, there is a tradeoff for such assurances and lower rates: the maximum loan amount for 2007 is $362,790 ($200,160 if the home is in a rural area), regardless of the homes value.

Jumbo loans (which have no limits) from private insurers are also available, but the cost of the loan could be as much as two percentage points higher each year.

Lenders typically charge an origination fee of 2% of the homeâ&#x20AC;&#x2122;s value (not the value being borrowed). A mandatory mortgage insurance premium adds another one-time fee of 2%; there are also various closing costs. Thus, the upfront costs on a reverse mortgage can easily exceed $12,000 for a $250,000 home. In the case of more expensive homes, the combined fees can be much higher. Regardless of the upfront (one time) fees, borrowers incur monthly interest charges (all of which are deferred until the borrower dies or permanently moves out) that compound annually.

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REAL ESTATE

10.2

The size of the reverse mortgage marketplace is still comparatively small. Close to 7.4 million traditional mortgages originated in 2005, versus about 60,000 reverse mortgages for the same period. Regardless of a homeâ&#x20AC;&#x2122;s value, all lenders will only finance a portion of its value (they need a cushion of safety with the collateral).

For example, a 68 year old with a $1 million house could get a jumbo reverse mortgage of about $386,000. The same homeowner would only receive between $108,000 and $210,000 with a HECM loan (the trade-off is lower fees and ongoing costs), depending on the location of the home. At age 72, a homeowner with the same $1 million house would get roughly $434,000 by using a jumbo reverse mortgage; at age 80 the loan would be approximately $494,000.

REVERSE MORTGAGE CALCULATOR AVAILABLE A private insurer now provides prospective borrowers a reverse mortgage calculator. To find out more information about the calculator, visit www.circlelending.com. According to Financial Freedom, the top five reasons why seniors are carrying a mortgage are:

Top 5 Reasons Seniors Still Have A Mortgage Never paid off existing mortgage

34%

Took out a second mortgage

21%

Receiving a tax break (interest deduction)

17%

Took out a reverse mortgage

1%

Other

27%

HOME FOR RETIREMENT INCOME According to an August 2007 survey by Bell Investment Advisors in Oakland, California, almost 70% of affluent baby boomers count their personal residence as a retirement asset. A quarter of the almost 70% stated that their home represented half or more of their retirement savings. Bell interviewed 500 people age 60 with more than $1 million in investible assets.

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EDUCATION

11.ADVANCED

11.1

DEGREE BENEFIT

According to the April 2007 issue of Journal of Accountancy, an advanced degree can bring, on average, a $16,000 bump in annual salary (see also www.worldwidelearn.com).

HOW ADULTS LEARN Whether you are giving a seminar or meeting with clients or prospects, it is important to know what influences investors. According to a study cited by SunAmerica, 50% of an adultâ&#x20AC;&#x2122;s ability to learn is determined by their mindset (thus, you should address objections early), 40% is determined by their perception of (or relationship with) the presenter, and just 10% is determined by content.

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