IBF - Updates - 2008 (Q1 v1.0)

INSTITUTE OF BUSINESS & FINANCE

QUARTERLY UPDATES Q1 2008

Copyright © 2008 by Institute of Business & Finance. All rights reserved.

v1.0

Quarterly Updates Table of Contents MFS, ETFS & ETNS HOW VANGUARD RANKS ETNS MONEY MARKET FUNDS TOP 10 ETFS ETF EXPENSE RATIOS

1.1 1.1 1.1 1.2 1.2

U.S. STOCKS U.S. STOCK MARKET VOLATILITY THE 20 LARGEST U.S. COMPANIES DOW JONES INDUSTRIAL AVERAGE S&P 500: NO GAIN IN 9 YEARS S&P 500 VOLATILITY STOCK MARKET DECLINES [1900-2008] S&P 500 RETURNS AFTER RECESSION LOWS S&P 500 DIVIDENDS U.S. STOCK RETURNS (2007)

2.1 2.2 2.2 2.3 2.4 2.5 2.5 2.6 2.7

RETIREMENT ROTH IRA VS. TRADITIONAL IRA 5% ANNUAL WITHDRAWAL PORTFOLIOS

3.1 3.1

ANNUITIES EXTREMELY LOW COST VARIABLE ANNUITY SUBSTANDARD ANNUITIZATION

4.1 4.1

GLOBAL INVESTING GLOBAL ECONOMICS COUNTRIES HOLDING U.S. DEBT FRONTIER INDEX GLOBAL STOCK RETURNS

5.1 5.1 5.1 5.2

FINANCIAL PLANNING BRIEF HISTORY OF RATING AGENCIES CLOSED-END FUND 2008 DISCOUNTS HOW CREDIT SCORES ARE DETERMINED GIFTS AND QUALIFYING FOR MEDICAID SOCIAL SECURITY SPOUSAL BENEFITS DEFINING A RECESSION OIL O’PLENTY HEALTH CARE COSTS RECESSION AND OTHER CONCERNS

6.1 6.1 6.1 6.2 6.3 6.4 6.4 6.4 6.5

REAL ESTATE HOME OWNERSHIP AS AN INVESTMENT MORTGAGE IMPACT REDUCTION REVERSE MORTGAGE CALCULATOR

7.1 7.1 7.2

BONDS MUNICIPAL BOND INSURANCE

8.1

THE ECONOMY U.S. RECEIPTS AND DISPERSEMENTS U.S. CREDIT CRUNCH AND BANKS

9.1 9.1

QUARTERLY UPDATES MFS, ETFS & ETNS

MUTUAL FUNDS & ETNS.

1.HOW

1.1

VANGUARD RANKS

The table below, provided by Vanguard and data from Lipper, shows what percentage of Vanguard funds beat their peer group averages for the periods ending December 31st, 2007. As you can see, the group did extremely well in the case of bond funds but had much less impressive results with equities.

Vanguard Peer Group Rankings as of 12-31-2007 1 Year

3 Years

5 Years

10 Years

Stock funds

40%

67%

77%

66%

Balanced funds

73%

70%

57%

89%

Bond funds

97%

96%

96%

100%

Money market funds

100%

100%

100%

100%

All Vanguard funds

60%

77%

83%

83%

ETNS It appears that exchange-traded notes (ETNs) may be a better investment vehicle than ETFs for certain illiquid securities, such as commodities and alternative-asset classes.

For advisors, knowing the difference is important since several sectors can be purchased either as an ETN or ETF. With an ETF, your clients are buying shares that represent a fractional ownership of a portfolio, similar to owning shares of a mutual fund.

ETNs are long-term debt securities that promise to pay investors the return of a particular index, minus fees. ETN investors have an additional concern, credit risk. The issuer of the ETN must be solvent when the investor wants to sell shares or when such shares reach maturity. An advantage of the ETN over the ETF is that it shifts any index tracking error to the issuer, not the investor. Like ETFs, ETNs can be sold short.

MONEY MARKET FUNDS By the end of the first quarter of 2008, $3.4 trillion was invested in money market funds.

By regulation, money market funds are required to disclose their holdings at least once every six months; other types of mutual funds must do so every three months.

QUARTERLY UPDATES

IBF | GRADUATE SERIES

MUTUAL FUNDS & ETNS.

1.2

TOP 10 ETFS The first table below shows the 10 largest ETFs, as measured by daily market activity; the second table ranks the 10 largest ETF by asset size (shown in billions of U.S. dollars).

10 Most Actively-Traded ETFs [April 2008]  S&P 500 SPDR (SPY)

 iShares MSCI-Japan (EWJ)

 Nasdaq-100 Index Stock (QQQQ)

 iShares MSCI EM (EEM)

 Financial Select Sector SPDR (XLF)

 Utrashort S&P 500 Proshares (SDS)

 iShares Russell (IWM)

 Energy Selector Sector SPDR (XLE)

 Ultrashort QQQ Proshares (QID)

 Dow Diamonds – DJIA (DIA)

10 Largest ETFs [April 2008]  S&P 500 SPDR ($85b)

 iShares S&P 500 ($18b)

 iShares MSCI EAFE ($48b)

 iShares Russell 1000 Growth ($14b)

 iShares MSCI EM ($24b)

 Vanguard Total Market VIPER ($10b)

 streetTRACKS Gold Trust ($19b)

 iShares Lehman 1-3 Tres. Bond ($10b)

 Nasdaq—100 Index Stock ($19b)

 iShares Russell 2000 ($10b)

ETF EXPENSE RATIOS The table below shows the average expense ratio for 12 different ETF categories, as of April 2008.

ETF Category Expense Ratios [April 2008]  Broad Market Indexes (0.38%)

 Global & Foreign Indexes (0.58%)

 Large Cap Indexes (0.28%)

 Emerging Markets Indexes (0.60%)

 Mid Cap Indexes (0.25%)

 Fixed Income Indexes (0.20%)

 Small Cap Indexes (0.33%)

 Commodity (0.75%)

 Industry & Sector Indexes (0.50%)

 Currency (0.40%)  Specialty (0.95%)

QUARTERLY UPDATES

IBF | GRADUATE SERIES

QUARTERLY UPDATES U.S. STOCKS

U.S. STOCKS

2.U.S.

2.1

STOCK MARKET VOLATILITY

Average daily price swings for the Dow Jones U.S. Total Market Index were more than 50% greater in 2007 than in 2006, as measured by standard deviation. Surprisingly, volatility in 2007 was still well below the 10-year average from 1998-2007; six of the past 10 years were more volatile than 2007. From the beginning of 1998 to the end of 2007, standard deviation for the index ranged from a low of roughly 10% (2004, 2005 and 2006) to a high of over 25% (2002).

Advisors who are looking for equities that have low correlation, as measured by Rsquared, to the overall U.S. stock market should consider the following sectors (listed from low to high):

Sectors with Low Correlation to U.S. Stock Market: 2003-2007 (R-squared) 

Travel & Tourism (2%)



Automobiles & Parts (19%)



Pharmaceuticals (5%)



Specialized Consumer Services (20%)



Insurance Brokers (6%)



Retailers (broadline) (26%)



Home Construction (6%)



Personal Products (27%)



Forestry & Paper (8%)



Semiconductors (31%)

The reasons for the low correlations are straightforward. For example, pharmaceutical profits are not tied as much to the overall economy as the prospects for a specific drug.

Similarly, cyclicals and capital-intensive sectors such as autos, forestry, paper and semiconductors can deviate substantially from overall domestic market returns. These ―maverick‖ sectors can be quite useful when diversifying a stock portfolio since they tend not to move with the market as a whole.

For advisors who have clients that do not like ―tracking error‖ (doing something the market is not), consider the following sectors, all of which have an R-squared of between 95% and 99%:

QUARTERLY UPDATES

IBF | GRADUATE SERIES

U.S. STOCKS

2.2

Sectors with Very High Correlation to U.S. Stock Market: 2003-2007 (R-squared of 95-99%) 

Commercial Vehicles



Restaurants & Bars



Waste & Disposal Services



Electric Utilities



Medical Supplies



Clothing & Accessories



Electronic Equipment



Life Insurance



Aerospace & Defense



Industrial Services

THE 20 LARGEST U.S. COMPANIES The table below shows the 20 largest U.S. companies, as measured by stock market capitalization as of the end of 2007 (source: Dow Jones). The market capitalization of each is shown in parentheses (in billions).

2007 Largest U.S. Companies 

Exxon Mobil ($504b)



Cisco Systems ($165b)



GE ($375b)



Google Class A ($163b)



Microsoft ($334b)



Altria Group ($159b)



AT&T ($253b)



Pfizer ($155b)



Proctor & Gamble ($228b)



Intel ($155b)



Chevron ($195b)



AIG ($149b)



Johnson & Johnson ($191b)



J.P. Morgan Chase ($148b)



Wal-Mart Stores ($189b)



IBM ($148b)



Bank of America ($186b)



Citigroup ($146b)



Apple ($173b)



Coca-Cola ($142b)

DOW JONES INDUSTRIAL AVERAGE On February 19th, 2008 the Dow Jones Industrial Average (DJIA) replaced two stocks and added two new companies. Gone are Altria Group with a market cap of $153 billion and Honeywell International with a market cap of $40 billion. Atria had been part of the Dow since 1985, Honeywell since 1925. The new companies are Bank of America ($190 billion) and Chevron ($169 billion). By stock market value, Bank of America was the largest U.S. bank and Chevron the second largest U.S. oil company after Exxon Mobil. Chevron has been in the DJIA twice before, the first time as Standard Oil of California (1924-1925).

QUARTERLY UPDATES

IBF | GRADUATE SERIES

U.S. STOCKS

2.3

The Dow was originally comprised of 12 ―smokestack‖ companies when it was first published on May 26th, 1896; it has been a 30-stock average since 1928. These changes to the Dow mark the first time the 111-year old average has made a change since 2004. The substitutions were made by the managing editor of The Wall Street Journal, which is owned by News Corporation. The table below lists the 30 stocks that make up the Dow, along with their stock symbol (shown in parentheses), the date the stock became part of the average and market value (shown in billions of dollars), as of February 11th, 2008.

2008 Dow Jones Industrial Average Exxon Mobil (XOM)

$446b

1928-present General Electric (GE)

$238b $222b $202b $190b $177b $169b $152b $148b $134b

2004-present

$57b

Boeing (BA)

$55b

3M (MMM)

$52b

Home Depot (HD)

$47b

American Express (AXP)

$47b

Caterpillar (CAT)

$44b

DuPont (DD)

$41b

1924-25; 1935-present $118b

1999-present AIG (AIG)

Walt Disney (DIS)

1991-present $122b

1997-present Intel (INTC)

$65b

1982-present $126b

1932-35; 1987 present Wal-Mart Stores (WMT)

United Technologies (UTX)

1999-present

1997-present Coca-Cola (KO)

$67b

1976-present

1991-present Citigroup (C)

McDonald’s (MCD)

1987-present

2004-present J.P. Morgan Chase (JPM)

$97b

1991-present

2008-present Pfizer (PFE)

Merck (MRK)

1933-34; 1939-present

1997-present Chevron (CVX)

$106b

1985-present

2008-present Johnson & Johnson (JNJ)

Verizon Commun. (VZ)

1979-present

1932-present Bank of America (BAC)

$108b

2004-present

1916-28; 1939-2004; 1999-present Proctor & Gamble (PG)

Hewlett-Packard (HPQ)

1997-present

1999-present AT&T (T)

$141b

1932-39; 1979-present $342b

1896-98; 1899-1901; 1907-present Microsoft (MSFT)

IBM (IBM)

Alcoa (AA)

$29b

1959-present $113b

General Motors (GM)

$13b

1915-16; 1925-present

S&P 500: NO GAIN IN 9 YEARS QUARTERLY UPDATES

IBF | GRADUATE SERIES

U.S. STOCKS

2.4

According to the March 26th, 2008 issue of The Wall Street Journal, the S&P 500, which represents about half of the $1 trillion invested in index funds, ended the previous day at 1,353—slightly below the 1,363 mark it reached in April 1999. If you factor in dividends and inflation, the S&P 500 has risen an average of just 1.3% a year over the past 10 years. For the past nine years, the index has fallen 0.4% a year; 1.4% a year over the past eight years. Over the past nine years, the S&P 500 has underperformed commodities, REITs, gold, foreign stocks and even U.S. Treasury bills (+4.7% a year). While stocks are down since 1999, they are up since mid-2001. Shiller also believes that home values will continue to weaken for years.

Shiller calculates that the S&P 500 traded in the late 1990s at more than 40 times its component companies’ profits, far above the historical norm of 16. As of March 2008, the S&P 500 is trading at more than 20 times profits. The Dow Jones Industrial Average, which contains fewer technology stocks, has risen less than 1% a year since January 2000.

Yale economist Robert Shiller, who predicted stock market troubles in his 2000 book, Irrational Exuberance, believes that excesses still exist. Richard Sylla of New York University points out that since 1800, when there have been exceptional gains in stocks (late 1810s, early 1820s, the 1840s, the 1860s and the early 1900s), such periods were followed by lengthy weaknesses. In a 2001 paper, Sylla forecast a 10-year period of deteriorating stock prices, ―When you have extraordinary returns, as we did from 1982 through 1999, then usually the next 10 years are not very good.‖ In short, Sylla believes that exceptional booms steal gains from the future (IBF also believes in a variation of this theme—reversion to the mean). Syllla feels that stocks will move up sometime during the next two years.

During an ―average‖ year, corporate profits represent 5-6% of total economic output on an after-tax basis. In 2006, that number was a record 9%. Since this number has historically reverted to its mean, Sylla believes that profits will fall to 3-4% for a couple of years.

S&P 500 VOLATILITY According to a 2008 Crestmont Research paper, the S&P 500 moves about 15% over a 12-month period; in late 2006 and early 2007 the number dropped to just 3%. Another way to measure historical volatility is to see the number of days the S&P 500 finishes higher or lower by 1% or more; since 1950, this has happened roughly four days out of every month. The average daily trading range has been 1.4% since the early 1960s.

QUARTERLY UPDATES

IBF | GRADUATE SERIES

U.S. STOCKS

2.5

As of early April 2008, the index experienced a five-month losing streak, a losing record that the S&P 500 has only experienced six times in the past. Historically, after such a losing streak, the S&P has gone on to post an 18% gain in the subsequent 12 months; in three of those six instances, returns exceeded 30%. The table below shows the number of quarters per year the S&P 500 had a negative return from 1998 through the first quarter of 2008.

S&P 500 Negative Quarterly Returns Per Year [4-2008] Year

- Quarters

Year

- Quarters

Year

- Quarters

1998

2

2002

2

2006

1

1999

1

2003

1

2007

2000

2

2004

1

2008

1 st

1 qtr. so far

STOCK MARKET DECLINES [1900-2008] The table below shows the frequency of declines in the DJIA since 1990 through the first quarter of 2008.

Dow Jones Industrial Average Declines [1990-2008] Type of Decline

Average Frequency

Average Length

Last Occurrence

Routine (-5% or more)

3 times a year

47 days

Nov. 2007

Moderate (-10% or more)

Once a year

113 days

Nov. 2007

Severe (-15% or more)

Every 2 years

216 days

Oct. 2002

Bear Market (-20% or more)

Every 3.5 years

332 days

Oct. 2002

S&P 500 RETURNS AFTER RECESSION LOWS The table below shows the returns of the S&P 500 for 3-12 month periods after the index has hit its recessionary low point. As you can see, from 1949 to 2008, the mean return has ranged from 16% (3 months after the low point) to 32% (12 months after the index reaches its low).

QUARTERLY UPDATES

IBF | GRADUATE SERIES

U.S. STOCKS

2.6

S&P 500 Returns After Lowest Point During A Recession Low Date

3 Months Later

6 Months Later

12 Months Later

6-13-1949

14%

19%

34%

9-14-1953

10%

17%

38%

10-22-1957

6%

10%

31%

10-25-1960

16%

25%

31%

5-26-1970

17%

21%

44%

10-3-1974

13%

30%

35%

3-27-1980

18%

31%

37%

8-12-1982

38%

42%

58%

10-11-1990

7%

29%

29%

9-21-2001

18%

17%

-14%

Mean

16%

24%

32%

S&P 500 DIVIDENDS Board of directors do not increase dividends unless they feel positive about the company’s future (one reason: they do not want to reduce the dividend in the future).

Since dividends cannot be manipulated, they do not present any accounting issues. For the 2007 calendar year, 78% of the companies in the S&P 500 paid dividends, up from 76.6% in 2006. Overall, the number of S&P 500 companies that pay dividends has steadily increased since 2001-2002, when it reached a low of 70%.

S&P 500 Dividend-Paying Companies 2006

2007

Dividend payers

383

390

Dividend increases

299

287

Initiation of dividend

7

11

Decrease in dividend

6

8

Suspension of dividend

3

6

QUARTERLY UPDATES

IBF | GRADUATE SERIES

U.S. STOCKS

2.7

U.S. STOCK RETURNS (2007) 2007 Dow Jones Investment Scoreboard 2006

2007

Dow Jones Industrial Average

19.05%

8.88%

S&P 500

15.79%

5.49%

Russell 2000

18.37%

-1.57%

Dow Jones Wilshire 5000

15.88%

5.62%

Long-Term Treasury Index

1.85%

9.81%

U.S. Credit Index AA-rated segment

4.32%

5.39%

Municipal Bond Index

4.84%

3.36%

Intermediate-Term Treasury Index

3.51%

8.83%

Mortgage-Backed Securities Index

5.22%

6.90%

Growth Fund Index

10.28%

8.45%

Growth and Income Fund Index

15.57%

4.68%

Balanced Fund Index

11.60%

6.76%

International Fund Index

25.89%

14.57%

Multi-Cap Value Index

17.07%

-0.54%

Money Market (taxable)

4.28%

4.48%

1-Year CD

3.70%

3.72%

30-Month CD

3.83%

3.71%

Money Market Deposit Account

0.80%

0.86%

Platinum

17.09%

34.15%

Gold

22.95%

31.35%

Silver

45.50%

15.35%

4.2%

0.8%

Stocks

Bonds (Leman Brothers Indexes)

Mutual Funds (Lipper Indexes)

Bank Instruments (Bankrate.com)

Precious Metals (futures contracts)

Residential Real Estate (repeat-sale index) Office of Federal Housing Enterprise Oversight

QUARTERLY UPDATES

IBF | GRADUATE SERIES

QUARTERLY UPDATES RETIREMENT

RETIREMENT

3.ROTH

3.1

IRA VS. TRADITIONAL IRA

There are four variables used when comparing a traditional IRA with a Roth IRA: [1] tax bracket during years of contribution, [2] retirement account’s assumed growth rate, [3] number of years of compounding, and [4] tax bracket when withdrawals are made. The obvious benefit of a traditional IRA is that contributions may be partially or fully deductible; the big benefit of a Roth IRA is that withdrawals (if made) are tax free. The table below shows all four of these variables.

Roth vs. Traditional IRA Traditional IRA

Roth IRA

[1] Contributions at 25% tax rate

$10,000

$7,500

[2] + [3] Value in 20 years

$32,071

$24,054

[4] Tax rates go down in retirement (e.g., 15%)

$27,260

$24,054

Tax rates go up (e.g., 28%)

$23,091

$24,054

Tax rates stay at 25%

$24,054

$24,054

5% ANNUAL WITHDRAWAL PORTFOLIOS Older clients are concerned with how much of their account can be liquidated for current income purposes, as well as the likely consequences. Based on an annual withdrawal rate of 5%, increased by 3% after the first year (e.g., taking out $5,000 the first year from a $100,000 account, $5,150 the second year, etc.), the table on the next page shows the effects of such a withdrawal plan for 10 different portfolios. The figures are based on data for the 38-year period ending December 31st, 2007.

Understanding the Table The fourth column (see next page), ―Worst 1-Yr. Drawdown,‖ factors in the portfolio’s performance plus the annual withdrawal (5% per year, increased by 3% after the first year). The fifth column, ―Loss Frequency,‖ shows how often, on an annual basis, the portfolio experiences a loss if the annual withdrawals are also included. This column is perhaps more ―real world‖ than the standard deviation column since few investors look at a portfolio’s standard deviation—what they really focus on is the total value of the portfolio from year-to-year.

QUARTERLY UPDATES

IBF | GRADUATE SERIES

RETIREMENT

3.2

One thing not fully appreciated is what happened to an all-cash portfolio versus one that was half in cash and half in bonds. Volatility increased (from 3.1% to 3.6%) but the worst one-year loss dropped from -13.9% to just -3.4%. Furthermore, the number of losing years dropped from 53% of the time down to 24% of the time; the average loss in those losing years also declined from -4.4% to -2.0%, over a 50% loss reduction. The sixth column, ―Average Annual Loss,‖ shows the typical loss for those years in which there is a loss—again, it factors in the 5% annual withdrawal.

Observations The all-cash portfolio has great appeal, particularly on a risk-adjusted return basis. The problem is that once you factor in 5% annual withdrawals, it begins to lose much of its luster. Moreover, if the impact of inflation and income taxes were also factored in (they are not), the results would truly be dismal. At the other end of the spectrum, investing 100% in the S&P 500 (note: this portfolio is not shown above) sounds good since it averaged 11.0% a year—until you look at its worst single-year performance, a loss of over 26%. Many investors may not have the patience to wait and recover from such a one-year drop. Equally important, the all-stock portfolio experienced quite a bit of volatility from year-to-year (standard deviation of 16.6%); meaning that returns ranged from -5.6% to +27.6% roughly two out of every three years (note: the ―other,‖ or third, year saw returns that ranged from -22.2% to +44.2%).

QUARTERLY UPDATES

IBF | GRADUATE SERIES

RETIREMENT

Portfolio

3.3

38-Yr IRR 7.0%

38-Yr. Std. Dev. 3.1%

Worst 1-Yr. Drawdown -13.9% (2007)

Loss Frequency 53%

Average Annual Loss -4.4%

1/2 cash 1/2 bonds

7.7%

3.6%

-3.4% (2004)

24%

-2.0%

1/3 cash 1/3 bonds 1/3 large stocks

8.7%

6.4%

-9.4% (1974)

18%

-4.3%

1/4 cash 1/4 bonds 1/4 large stocks 1/4 small stocks

9.5%

9.3%

-14.2% (1974)

24%

-5.3%

1/5 cash 1/5 bonds 1/5 large stocks 1/5 small stocks 1/5 foreign stocks

9.9%

10.3%

-16.9% (1974)

21%

-8.0%

1/6 cash 1/6 bonds 1/6 large stocks 1/6 small stocks 1/6 foreign stocks 1/6 equity REITs

10.2%

10.6%

-18.8% (1974)

16%

-10.0%

1/7 cash 1/7 bonds 1/7 large stocks 1/7 small stocks 1/7 foreign stocks 1/7 equity REITs 1/7 commodities

11.2%

8.6%

-10.2% (1974)

21%

-3.9%

20% cash; 40% bonds; 12% large stocks; 8% small stocks; 10% foreign stocks; 5% REITs; 5% commodities 40% large stocks 60% bonds

9.6%

5.9%

-7.3% (1974)

16%

-2.6%

9.3%

8.0%

-12.2% (1974)

21%

-4.7%

60% large stocks 40% bonds

9.7%

10.7%

-18.8% (1974)

26%

-6.6%

100% cash

QUARTERLY UPDATES

IBF | GRADUATE SERIES

RETIREMENT

3.4

Risk-Return Tradeoffs (the efficient frontier) The highest returning portfolio for the 1970-2007 period was the one that was comprised of seven equal parts (cash, bonds, large stocks, small stocks, foreign stocks, REITs and commodities), it averaged over 11% a year with an 8.6% standard deviation. This seven-part portfolio had better returns and less risk than any portfolio whose returns averaged 9.5% or higher—except the seven-part portfolio that was not equally weighted (20% cash, 40% bonds, 12% large stocks, 8% small stocks, 10% foreign stocks, 5% REITs and 5% commodities).

For clients whose priority is to experience the fewest losing years after factoring in a 5% annual withdrawal, the two best portfolios were 100% cash and the unequally weighted seven-part portfolio described above. Between the two, the seven-part portfolio would have been a much better choice for the investor concerned with the effects of inflation and/or income taxes.

The Portfolios o o o o o o o

Cash = 3-month U.S. Treasuries Bonds = Lehman Brothers Intermediate-Term Bond Index Large Stocks = S&P 500 Small Stocks = Ibbotson Small Stocks (1970-1978) Russell 2000 Index (19792007) Foreign Stocks = EAFE Index Equity REITs = NAREIT Equity Index Commodities = S&P GSCI Commodity Index

The Advisor’s Decision As the advisor, your job is to point out: (1) historical returns range wildly and no one knows what the future will hold except that there will be many surprises, (2) the cumulative effects of inflation are meaningful and rarely reflected in any performance tables, (3) the more conservative investments are usually fully taxable (e.g., cash and bonds), (4) if in doubt, diversify into a number of categories (e.g., a seven-asset or more portfolio), and (5) if the client does not understand each asset category and is easily overwhelmed, consider a basic conservative (60% bonds and 40% large stocks) or somewhat moderate (60% large stocks and 40% bonds) portfolio—if there is any doubt, emphasize the bond weighting (also consider using a fixed-rate annuity for part of the bond portion).

QUARTERLY UPDATES

IBF | GRADUATE SERIES

QUARTERLY UPDATES ANNUITIES

ANNUITIES

4.EXTREMELY

4.1

LOW COST VARIABLE ANNUITY

Jefferson National Life’s Monument Advisor charges no upfront commissions and no surrender charges but provides no death benefit. Monument Advisor contract owners pay just $20 a month in fees (and no other M & E expenses), whether the investment is worth $5,000 or $1,000,000.

SUBSTANDARD ANNUITIZATION Advisors generally consider annuitization for conservative clients in good health trying to maximize their current income. However, a number of insurers (see table below) offer substandard annuitization, designed to increase payments for those who do not have great health. Unlike traditional annuities, substandard annuities require underwriting.

The agent gathers medical information from the client and submits it to one or more substandard carriers.

After processing the information, the insurance carrier will provide an ―age rating‖ (e.g., someone age 67 may get an age rating of 70 or higher if their health is below average for their age). Some companies will also provide an annuitization quote, other carriers will allow the agent to run his or her own quotes based on the ―revised‖ age. For example, a 67 year old may have the health of a 70 year old, thereby qualifying for 14% monthly payment increase (see table below).

Insurers Offering Substandard Annuities 

AIG American General

 Protective Life

 Jefferson-Pilot Life



Fidelity & Guaranty Life

 Aviva Life

 Presidential Life



Golden Rule Insurance

 Genworth Financial

 United of Omaha Life



Lincoln Benefit Life

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ANNUITIES

4.2

Monthly Income for $100,000 Substandard Annuity Male, age 60 Rated Age

Monthly Income

Increase Over Standard Annuity

Rated Age

Monthly Income

Increase Over Standard Annuity

65

$680

0%

71

$796

17.0%

66

$697

2.4%

72

$821

20.7%

67

$714

5.0%

73

$847

24.6%

68

$733

7.8%

74

$876

28.8%

69

$753

10.7%

75

$906

33.2%

70

$774

13.9%

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QUARTERLY UPDATES GLOBAL INVESTING

GLOBAL INVESTING

5.GLOBAL

5.1

ECONOMICS

During 2007, the developing countries produced over 52% of global growth, compared to 37% during the late 1990s; China alone produced 18% of global GDP, compared to 15% for the United States. Developing countries now represent 29% of the total world’s output, compared to 18% in 1995. For 2008, the World Bank forecasts that the economies of developing countries will grow over 7%, compared to 3% in older industrialized nations.

As of the beginning of 2008, the capitalization of the U.S. stock market was $17.5 trillion, versus $17.8 trillion for all of the developing countries (which was just $2.2 trillion in 2000). In 2000, consumer spending for the 17 largest emerging economies was equal to 48% of U.S. consumer spending; in 2007 that number increased to 65%. The United States’ share of global imports fell from over 20% in 2000 to 14% in 2007. The import share of the developing countries has grown from 33% in 2000 to 41% in 2007.

COUNTRIES HOLDING U.S. DEBT As of June 2007, the major foreign holders of U.S. Treasury securities were: Japan ($612b), China ($405b), U.K. ($190b), oil exporting countries ($122b), and Caribbean banking centers ($49b).

FRONTIER INDEX The Merrill Lynch Frontier Index tracks 50 of the largest and most highly-traded stocks in 17 countries, from Kuwait to Kazakhstan; stocks that are so much off the radar screen, they do not qualify for ―emerging markets‖ status. Roughly half of the index is comprised of Middle Eastern stocks. The market value of the 50 stocks in the index is $366 (about the same market capitalization as GE). Other markets represented in the index are Nigeria, Cyprus, Vietnam and Pakistan.

The two biggest appeals of frontier stocks (and funds) is that the data, so far, shows that correlations to other markets is random and that returns can be quite attractive (e.g., from the beginning of 2007 through February of 2008, the Merrill index was up 70%). Another short-term appeal is the fact that a number of Persian Gulf countries went through a bubble period that ended in large stock market price drops during 2006.

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GLOBAL INVESTING

5.2

GLOBAL STOCK RETURNS 2007 Dow Jones Global Index Returns Country

U.S. Dollars

Local Currency

Country

U.S. Dollars

Local Currency

Brazil

71.1%

42.6%

Greece

29.8%

17.1%

Malaysia

44.6%

35.5%

Singapore

27.6%

19.7%

Hong Kong

44.5%

44.9%

Canada

27.1%

7.8%

Thailand

39.0%

29.5%

Norway

26.8%

10.6%

Indonesia

39%

45.1%

Australia

25.3%

12.4%

Finland

39.0%

25.3%

Portugal

24.5%

12.3%

Philippines

36.7%

15.1%

Chile

23.0%

15.1%

South Korea

33.6%

34.5%

Spain

17.8%

6.2%

Germany

30.5%

17.7%

Denmark

17.6%

6.1%

Country

U.S. Dollars

Local Currency

Country

U.S. Dollars

Local Currency

Iceland

13.1%

-0.2%

U.S.

3.8%

3.8%

South Africa

12.6%

9.1%

New Zealand

2.2%

-6.4%

Netherlands

12.0%

1.0%

Italy

1.7%

-8.3%

France

11.3%

0.4%

Austria

1.6%

-8.4%

Mexico

10.8%

11.7%

Sweden

-3.1%

-8.5%

Taiwan

6.5%

6.0%

Japan

-6.0%

-11.9%

Belgium

5.6%

-4.7%

Ireland

-19.2%

-27.1%

Switzerland

5.6%

-2.0%

World

8.4%

U.K.

3.8%

2.1%

World, ex. U.S.

11.8%

For the 2007 calendar year, India’s stock market, as measured by the Bombay Sensex Index, was up 39.3% in local currency. China’s Shenzhen A Shares were up 167.0% and their Shanghai A Shares were up 96.1%, both in local currency terms.

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QUARTERLY UPDATES FINANCIAL PLANNING

FINANCIAL PLANNING

6.BRIEF

6.1

HISTORY OF RATING AGENCIES

Since 1975, the SEC has limited competition in the market for credit ratings by appointing a very limited number of companies as ―Nationally Recognized Statistical Rating Organizations (NRSROs). Starting in 1992, the SEC went an entire decade without allowing a single new competitor into the market. Thomson reports that in 2007, Moody’s rated 95% of corporate bonds, while S&P rated 93%. Fitch, at 37%, is the only other firm with significant market share. S&P rates 96% and Moody’s rates 86%of mortgage-backed and asset-backed issues, which represent pools of auto loans, credit card receivables and the like; Fitch rates 58%.

CLOSED-END FUND 2008 DISCOUNTS As of the middle of January 2008, closed-end funds (CEFs) were trading at an average discount to NAV of just under 7% (reaching almost an 11% discount in November 2007).

Over the past 10 years (ending 12-31-2007), shares usually sold for 4% below NAV, according to Wachovia Securities. The larger than normal gap represents investor concerns over the credit markets and, to a lesser degree, tax-related trading.

During January of 2007, a record for the largest CEF was set by Alpine Total Dynamic Dividend Fund, when it raised $3.5 billion; a month later, Eaton Vance raised $5.5 billion for its Tax-Managed Global Diversified Equity Income Fund. Less than a year later, the Eaton Vance investors had experienced a cumulative loss of over 8%, even though the fund’s assets had appreciated over 7%. Of the seven $1+ billion CEFs that hit the market in 2007, all but one are trading at discounts of more than 5%. It appears that the marketplace has viewed all of these CEFs the same, regardless of their portfolio composition.

HOW CREDIT SCORES ARE DETERMINED Credit scores are based on five criteria (weightings shown in parentheses): payment history (35%), amount you owe (30%), length of credit history (15%), types of credit you are using (10%) and new credit (10%). Your clients can improve their credit scores by following these steps: Step 1: Order a credit report from all three major credit-reporting bureaus at www.annualcreditreport.com. By law, a person is entitled to one free credit report a year from each of the reporting agencies: Equifax, Trans-Union and Experian.

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FINANCIAL PLANNING

6.2

Step 2: Once your client receives the credit reports, they should be reviewed for mistakes. Credit bureaus are required to investigate disputed items, usually within 30 days.

Step 3: Buy your FICO credit score from Equifax for $8; you can order your credit score from Fair Issac’s website (www.myfico.com), prices range from $16 for a FICO score to $48 for all three credit scores and reports (note: there may be variations among the three reporting agencies because some lenders do not report to all three credit bureaus). The free credit report your client is entitled to (Step 1) does not include a credit score.

Step 4: Since payment history represents 35% of the overall FICO credit score, it is important that bills are paid on time. A late payment can stay on a report for up to seven years. On a positive note, lenders pay more attention to recent history than to any past misdeeds.

Step 5: Encourage your client to reduce any outstanding debt (30% of the overall score).

For example, if someone has a $5,000 credit limit and a current balance of $2,500, their ―credit utilization‖ is 50%. A credit score reflects the debt ratio for each credit card.

Step 6: Avoid or minimize new credit accounts. Every time a new credit card or line of credit is sought, the lender will request a credit report. Lenders believe that someone seeking additional credit is more likely to fall behind on payments. Furthermore, the addition of a new line of credit means that the average age of all credit accounts combined drops, which could also hurt the credit score (length of credit history is 15% of the overall score).

GIFTS AND QUALIFYING FOR MEDICAID Individuals generally become eligible for Medicaid after using up all but about $2,000.

Some people try to get around the intent of the law by making cash gifts to their children.

However, Medicaid has a five-year look-back period, potentially penalizing an applicant or Medicaid recipient for any gifts made up to five years ago (note: the previous lookback period was three years).

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FINANCIAL PLANNING

6.3

Besides increasing the look-back period, Medicaid has also changed the penalty period.

In the past, the penalty period was calculated based on when the gift was made; the clock now starts when someone applies for Medicare. For example, suppose that under the old rules, a New York City resident gave away $27,000 a year before applying for Medicaid (note: $27,000 represents the cost of three months of long-term in NYC). In such an instance, there would be no negative consequences for the applicant because an application was not made for 12 months (nine months longer than the potential three month penalty period). Under the new rules, there would definitely be consequences— there would be no Medicaid payments for the first three months of the nursing home stay.

Your clients can find out the probability of needing nursing home care based on their age and gender as well as the average length of stay by contacting the New England Journal of Medicine which periodically collects such data from the National Nursing Home Survey (NNHS).

SOCIAL SECURITY SPOUSAL BENEFITS When you begin receiving Social Security retirement benefits, your spouse may also qualify to receive a check based on your earnings. You cannot receive spousal benefits until your spouse has claimed Social Security. However, once you reach age 62, you can always apply for benefits based on your own earnings.

When a spouse files for a reduced benefit based on his or her earnings, Social Security checks to see if the applicant is also eligible for a spousal benefit. If so, that spouse is deemed to have filed for both her benefit (as a worker) and the spousal benefit. In such a situation, the filing spouse will usually receive the higher of the two amounts. As a side note, you cannot claim spousal benefits at age 62 based on the other spouse’s earnings and then claim benefits at full retirement age based on the applicant’s earnings (assuming the other spouse is already collecting benefits).

If a 62-year-old working spouse claims reduced benefits based on his or her earnings, he or she can ―step up‖ to a spousal benefit when that spouse retires (this assumes that the other spouse, not yet retired, has higher earnings than the 62-year-old spouse). However, often it is best to wait until ―full retirement age‖ (age 65-67, depending upon your year of birth). For example, suppose Mr. Smith is expected to receive $1,800 a month from Social Security at his full retirement age. Based on her earnings, Mrs. Smith is scheduled to receive $800 a month at her full retirement age. If Mrs. Smith does wait until this time, and assuming that Mr. Smith has also waited and is receiving benefits, she will then receive $900 a month (the higher of her full benefit or ½ the benefit of Mr. Smith).

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FINANCIAL PLANNING

6.4

DEFINING A RECESSION The academic group, The National Bureau of Economic Research, is responsible for formally determining when a U.S. recession begins and ends, but waits until the data cannot be disputed, typically several months after the recession actually began. For example, in March 2001, eight months after the fact, the bureau announced the U.S. was in a recession. The irony was that it was later determined that when the announcement was made, the recession was already over.

OIL O’PLENTY Although estimates vary, it is generally agreed that there are approximately 6-8 trillion barrels for conventional oil reserves and another 6-8 trillion for unconventional oil resources (e.g., shale oil, tar sands, extra heavy oil, etc.). As a point of comparison, the world has consumed a total of one of those 12-16 trillion barrels since it began using oil.

Currently, the oil industry is able to recover an average of just one of three barrels from conventional resources and much less for unconventional. If there were just a 10% future increase in production, the increase would translate into another 50 years of supply at current consumption rates. Current world oil consumption is about 86 million barrels per day, with projected annual increases of 0-2%.

HEALTH CARE COSTS Health care costs account for 1/6th of the economy, compared to 1/10th in the early 1980s. In 2005, the U.S. spent $2 trillion on health care, the equivalent of $6,700 per person. About 16% of U.S. citizens are uninsured; Hawaii has required employers to provide medical insurance for employees since 1974. Young adults are the most likely group to be uninsured; ages 18 and 34 account for 25% of the population but 41% of those without insurance.

A 2008 report by the Center for Retirement Research at Boston College estimates that even before health care costs are factored in, 44% of working age households are at risk of being unable to maintain their standard of living in retirement. Add in health expenses, and the figure rises to 61%. The table below shows the amount of a single-premium fixed-rate annuity needed at retirement to cover projected out-of-pocket health care costs for people retiring at age 65, in 2007 dollars.

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6.5

Investment Needed To Fund Health Care Costs Retirement Year

Single

Couple

2010

$103k

$206k

2020

$142k

$284k

2030

$189k

$378k

2040

$246k

$492k

RECESSION AND OTHER CONCERNS As of April 2008, by a 3–to-1 margin, economists surveyed by The Wall Street Journal believe the U.S. is in a recession. When asked what the biggest downside risk was, 35% said further deterioration in the credit markets, 25% believed it would be a further drop in consumer spending and 13% felt it would be continued housing weakness.

The consensus view among the economists was that the unemployment rate would increase from 5.1% to 5.6% by December. Just 21% of the economists surveyed expect home prices to bottom in 2008; 67% expect the bottom to be in 2009 while 12% believe it will not happen until 2010.

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FINANCIAL PLANNING

7.HOME

7.1

OWNERSHIP AS AN INVESTMENT

Advisors know that not even a stock market trader would put 60% or 70% of their portfolio in just one stock. Yet, tens of millions of people have that much or more of their total net worth in just one house. Over the past 30 years (1977 to 2007), home prices, on average, increased 481%; San Francisco home owners enjoyed an 1,125% increase, while residents of Houston experienced just 200% appreciation (source: Office of Federal Housing Enterprise Oversight).

If you bought a house in Los Angeles in 1990, just as that real estate marketplace turned downward, you would have had to wait 10 years before the home’s value returned to what you paid for it. If you bought in Rochester, N.Y. in 1980, your annual appreciation rate for the next 25 years was 4% (between 0-1% if you adjust for inflation). If you bought in Dallas in 1986, as the oil boom went bust, your home would not have appreciated at all before 1998.

To put things in perspective, if you bought a $50,000 home in San Francisco in 1977, it was worth $613,000 by the beginning of 2007 (1,125% appreciation); after ownership expenses (e.g., mortgage interest, taxes, insurance, maintenance and major repairs), the true profit would have been $219,000. The comparable house in Los Angeles would have been worth $593,000 in Los Angeles (1,085%), $549,000 in New York (998%) and $432,000 in Washington (763%)—all of these figures are before ownership costs are subtracted. In some large cities, homeowners did not fare as well during the 1977 to 2007 period. In Chicago, a $50,000 home grew to $282,000 (463%), $176,000 in Dallas (252%) and just $147,000 in Houston (193%). After deducting ownership expenses in these three cites, homeowners would have actually lost money over this 30-year period (not to mention the effects of inflation along with the tax ramifications upon sale).

MORTGAGE IMPACT REDUCTION By adding an additional $300 per month to the payment on a 6.25%, 30-year, $300,000 loan, the borrower will end up saving 10 years of payments and $83,000 of after-tax money. Adding just a $100 a month (instead of $300) results in a savings of $57,000 of interest payments and shaves four years off a 30-year mortgage. Change the $100 to $500 per month one saves $170,000 and reduces the length of the mortgage from 30 to 17 years.

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FINANCIAL PLANNING

7.2

REVERSE MORTGAGE CALCULATOR One way to figure out how much your client can net out from a reverse mortgage is to go to the web site goldengateway.com (and click on ―Do the Math‖). By plugging in the client’s zip code, age and value of the home, the site shows the different lump sums and monthly payouts available from different lenders. A separate chart shows the closing costs and related fees (which are typically quite high).

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BONDS

8.MUNICIPAL

8.1

BOND INSURANCE

Roughly half of the $2.6 trillion municipal bond market is insured by firms such as MBIA, Ambac Financial Group and Financial Guarantee Insurance. If there is a default, the insurer guarantees repayment. Fortunately, few municipal bonds ever default.

For example, municipal bonds with a BB rating have a cumulative average 10-year default rate of 1.74% since 1970 (meaning an average of just 0.74% per year); BB rated corporate bonds have a 29.93% 10-year cumulative default rate (meaning an average of 2.99% per year), according to Municipal Market Advisors.

The security of municipal bonds becomes much greater when looking at BBB rated bonds by S&P, a mere 0.32% cumulative average over 10 years (or 0.03% per year), versus 0.6% cumulative 10-year average for AAA rated corporate bonds (or 0.06% per year).

Before the 2007-2008 bond-insurer crisis, bond insurers charged about 30% of the interest-rate savings an issuer would get; during the early parts of 2008, that figure rose to 80-90%. In some cases, the need for bond insurance seems weak; the state of California takes in over $100 billion of revenue each year (posing the question, ―Would you rather be exposed to the state of California for 30 years or the credit of a bond insurer for the next 30 years?‖).

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THE ECONOMY

9.U.S.

9.1

RECEIPTS AND DISPERSEMENTS

For fiscal year 2009, total receipts collected by the U.S. Government are expected to be $2.7 trillion. The largest source, $1.26 trillion, will come from individual income taxes, followed by $949 from Social Security and Medicare payroll taxes, $339 from corporate income taxes and $152 billion from excise and other taxes.

The proposed $3.1 trillion outlays for fiscal year 2009 are: $992 billion paid to Medicare, Medicaid and similar beneficiaries, $644 billion paid to Social Security recipients, $671 billion to defense, $541 billion to non-defense spending and $260 billion of net interest payments.

U.S. CREDIT CRUNCH AND BANKS As of the beginning of 2008, losses from the credit crunch represented 0.7% of U.S. GDP, versus 3.2% during the savings and loan collapse in the late 1980s. Bank deregulation in the 1970s and 1980s spurred the creation of larger banks and greater competition. Between 1975 and 2005, the number of banks declined from 13,500 to 7,500, but the number of bank locations nearly doubled to 80,300. Since 1934, there have only been two years when no U.S. banks failed: 2005 and 2006, according to FDIC. During the S&L crisis of 1988-89, U.S. banks failed at a rate of more than two every business day. According to FDIC, real estate holdings accounted for 58% of total assets for U.S. banks in 2006.

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