IBF - Updates - 2008 (Q3 v1.0)

INSTITUTE OF BUSINESS & FINANCE

QUARTERLY UPDATES Q3 2008

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

v1.0

Quarterly Updates Table of Contents COMMODITIES INTRO

1.1

FINANCIAL PLANNING SEQUENCE OF RETURNS MATTERS BACK-TESTED WITHDRAWAL RATES WEB SITES FDIC CONCERNS TAXABLE FIXED-INCOME ALLOCATION BOOKS ON ―MUST READ‖ LISTS WORDS OF WISDOM QUOTES ABOUT INVESTING

2.1 2.1 2.3 2.12 2.13 2.13 2.14 2.15

MUTUAL FUNDS HEDGE FUNDS HARVARD‘S ENDOWMENT FUND MONEY MARKET FUND HISTORY

3.1 3.1 3.3

RETIREMENT SOCIAL SECURITY PAYBACK STRATEGY REVERSE MORTGAGE LEGISLATION

4.1 4.1

STOCKS BERKSHIRE HATHAWAY PORTFOLIO

5.1

INDEX INVESTING PASSIVE INVESTING SCOTT BURNS: COACH POTATO PORTFOLIO BILL SCHULTHEIS: COFFEEHOUSE PORTFOLIO WILLIAM J. BERNSTEIN: NO-BRAINER PORTFOLIO TED ARONSON PORTFOLIO DAVID SWENSEN PORTFOLIO BEN STEIN‘S LONG-TERM PORTFOLIO AMERICAN ASSOCIATION OF INDIVIDUAL INVESTORS BARTON MALKIEL JOHN BOGLE‘S PERSONAL PORTFOLIO CHARLES KIRK: LONG-TERM RETIREMENT PORTFOLIO JONATHAN CLEMENTS PORTFOLIO PAUL MERRIMAN PORTFOLIO TIMOTHY MIDDLETON PORTFOLIO FRANK ARMSTRONG III PORTFOLIO JIM LOWELL PORTFOLIO ANDREW TOBIAS PORTFOLIO STANDARD & POOR‘S PORTFOLIO JOHN WASIK PORTFOLIO RICHARD JENKINS PORTFOLIO KIPLINGER PORTFOLIO MORNINGSTAR PORTFOLIO J.D. STEINHILBER PORTFOLIO CARL DELFELD PORTFOLIO DAVID JACKSON PORTFOLIO LARRY SWEDROE PORTFOLIO STEVEN SCHOENFELD PORTFOLIO DR. MARVIN APPEL PORTFOLIO XTF PORTFOLIO PASSIVE INVESTING SUMMARY

6.1 6.2 6.4 6.6 6.7 6.8 6.9 6.11 6.11 6.12 6.14 6.15 6.17 6.19 6.20 6.21 6.22 6.23 6.24 6.25 6.26 6.27 6.30 6.31 6.32 6.32 6.33 6.35 6.36 6.37

ANNUITIES 2007 VARIABLE ANNUITY SALES IBBOTSON STUDY BACKGROUND OVERVIEW OF STUDY‘S CONCLUSIONS QUICK REVIEW OF GMWB RIDER CONCLUSIONS

7.1 7.1 7.3 7.3 7.14

QUARTERLY UPDATES COMMODITIES

COMMODITIES

1.1

1.INTRO

Adding commodities to a portfolio may reduce risk and/or increase overall return.

However, the volatility of this asset class on its own can be extreme, particularly with certain commodities over selected periods of time, as shown in the table below (source: Thomson Reuters). Predictability is increased if a broad-based commodity index is used.

However, potential gains and losses become incredible if a commodity is purchased as a futures contract, which typically requires only a deposit of 5-10% of the underlying value. For example, if futures contracts for wheat were purchased during the January 2007 through August 2008, the gain from the low ($4.19) to the high ($12.80) would have been 2,050% (assuming a 10% deposit—the typical requirement for a futures contract).

Commodity Price Swings [January 2007—August 2008] Commodity

Low Price

High Price

Change

Coffee (cents a pound)

$1.01

$1.65

63%

Copper (cents a pound)

$2.40

$4.08

70%

Gold (dollars a troy oz.)

$637

$1,003

57%

Soybeans (cents a bushel)

$7.10

$16.58

134%

Wheat (cents a bushel)

$4.19

$12.80

205%

The two best-known commodity indexes are the S&P Goldman Sachs Commodity Index (GSCI) and the Dow Jones-AIG (DJ-AIG). Over the past 16 years, the correlation coefficient between these two indexes has been 0.88. From 1992 through 2007, the GSCI has experienced more volatility than the DJ-AIG. Over this 16-year period, GSI had annualized returns of 7.7%, a standard deviation of 26%, a worst-year loss of 35.8% and a maximum one-year gain of 49.7%. Over this same period, the DJ-AIG averaged 8.8% and had a standard deviation of 17% (36% lower than GSCI); its worst-year loss was 27% and its best one-year gain was 31.8%.

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1.2

The table below shows the correlation between these two commodity indexes and five different asset classes from 1992 through 2007 (source: Craig Israelsen). As you can see, the correlations are all random.

Commodity Index Correlations

Asset Category

GSCI/DJ-AIG Correlation

S&P 500

0.0

LB Aggregate Bond

0.0

Russell 2000

0.1

3-Month T-Bill

0.0

EAFE

0.2

Asset Category

GSCI/DJ-AIG Correlation

The next table shows returns for both commodity indexes (S&P GSCI and DJ-AIG) for the 16-year period, 1992 through 2007. The table also includes returns for the S&P 500 and the Lehman Brothers Aggregate Bond Index. The final table summarizes the previous table by showing cumulative results for the 16-year period.

Annual Returns [1992-2007] Year

GSCI

AIG

S&P

Bonds

Year

GSCI

1992

7.4%

3.7%

7.6%

7.4%

2000

49.7% 31.8% -9.1% 11.6%

1993

-1.1% 10.1% 12.3%

9.7%

2001

31.9% 19.5% 11.9%

1994

5.3%

-2.9%

2002

32.1% 25.9%

1995

20.3% 15.2% 37.6% 18.5%

2003

20.7% 23.9% 28.7%

4.1%

1996

33.9% 23.2% 23.0%

3.6%

2004

17.3%

9.1%

10.9%

4.3%

1997

14.1% -3.4% 33.4%

9.6%

2005

25.5% 21.4%

4.9%

2.4%

1998

35.7% 27.0% 28.6%

8.7%

2006

15.1%

2.1%

15.8%

4.3%

1999

40.9% 24.3% 21.0% -0.9%

2007

32.7% 16.2%

5.5%

7.0%

16.6%

1.3%

AIG

S&P

Bonds 8.4%

10.3% 22.1%

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1.3

As you can see from the summary results below, the two commodity indexes (GSCI and DJ-AIG) had annualized returns that were only a little higher than bonds (7.7% and 8.8% vs. 6.3%) but with a standard deviation that was 240%-420% higher (26% and 17% vs.

5%).

Summary Results [1992-2007] GSCI

AIG

S&P

Bonds

16-Year Annualized

7.7%

8.8%

10.3%

6.3%

16-Year Standard Deviation

26%

17%

17%

5%

Maximum Annual Loss

-36%

-27%

-22%

-3%

Maximum Annual Gain

50%

32%

38%

18%

Worst 3-Year Cumulative

-26%

-13%

-38%

-11%

Growth of $10,000

$33k

$39%

$48k

$28k

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FINANCIAL PLANNING

2.SEQUENCE

2.1

OF

RETURNS MATTERS

Surprisingly, for the growth-oriented investor, the sequence of gains and losses often times makes no difference, the ending value is identical. For example, if you take the annual total return figures of the S&P 500 for the period 1968 through 2007, the annualized return is 10.53%. If you reverse the order (meaning 1968‘s return becomes 2007‘s return, 1969‘s return becomes 2006‘s return, etc.), annualized returns still average exactly 10.53%. Phrased another way, 2007‘s return now becomes what the S&P 500 returned in 1968, 2006‘s return becomes what the S&P 500 did in 1969, etc.). The standard deviation is also the same in both cases, 16.3%.

However, if money is taken out each year, the sequence of gains and losses becomes very important. For example, using the same period (1968-2007), an initial investment of $100,000, and then withdrawals of 5% inflation-adjusted each year, the initial investment grows 150% (excluding the annual income stream). If you reverse annual returns as described above, original principal grows 1,300%. As a side note, standard deviation is still the same, 16.3% annually.

BACK-TESTED WITHDRAWAL RATES Designing and implementing a successful withdrawal program for retired clients is critical. In recent years, more attention has been given to topics such as what the appropriate allocation should be and what withdrawal rate is sustainable. One concern advisors have is the validity of the historical time frame selected and how much results would vary if the time frame began or ended a couple of years earlier or later (capturing a particularly good or bad period in the market).

The table below shows the 25 rolling 25-year periods from 1959 through 2007. And, although every 25-year period is included in the computations, there are still two valid considerations not answered: [1] would results be different if the starting period were 1958, 1955, or some year in the 1960s and [2] how different are results if the rolling period is 10, 15 or 20 years instead of 25 years. A number of the advisor‘s clients may not have the patience to consider a 25-year hold; others may believe that they will not live another 25 years or that their financial picture is likely to change drastically during the next 10-15 years (e.g., death of a spouse, need for nursing home, unexpected medical operation, etc.).

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2.2

The beginning point can make quite a difference. For example, a retiree starting a $100,000 retirement portfolio at the beginning of 1998 would have had $104,790 by the end of 2007; if the starting point was the beginning of 1999, the ending value would have been just $84,350 (note: both examples assume a 5% annual withdrawal rate, increased by 4% each year and a portfolio mix of 60% in the S&P 500 and 40% in the Lehman Brothers U.S. Aggregate Bond Index). It should be pointed out that S&P 500 returns in the late 1990s and early 2000s were very volatile (e.g., 1998 = 28.6%, 1999 = 19.5%, 2000 = -10.1%, 2001 = -13.0%, 2002 = -23.4% and 2003 = 26.4%).

From 1959 through 2007 there were 25 rolling 25-year periods. The ―stocks‖ used below represent returns from the S&P 500; ―bonds‖ are the Citigroup Long Term High Grade Corporate Bond Index. Portfolios are rebalanced annually. The rate of withdrawal increases by 4% each year to offset inflation. For example, if $100,000 were initially invested and 5% were taken out each year, the first year‘s withdrawal would be $5,000, $5,250 the second year, etc.

Odds Of Not Running Out Of Money All 25-year rolling periods from 1959 through 2007 rate of withdrawal

100% stocks

60% stocks 40% bonds

50% stocks 50% bonds

40% stocks 60% bonds

100% bonds

4%

100%

100%

100%

100%

84%

5%

100%

100%

88%

76%

64%

6%

72%

56%

56%

56%

44%

In the article, ―Determining Withdrawal Rates Using Historical Data,‖ author William Bengen suggests that the best initial portfolio for retirees is an equity weighting of 5075%, based on historical returns.

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2.3

WEB SITES Listed below is a summary of web sites that can aid advisors in their daily practice. The sites are grouped in the following categories:  Market Statistics  Mutual Funds ETFs

 REITs and  Personal Finance

 Tax Information  Insurance Products

 International

 Retirement Planning

 Federal Government

 Bonds

 Estate Planning

 Economic Data

Market Statistics Dow Jones Indexes [www.djindexes.com] [cost: free] Extensive database of historical returns and composition of U.S. and foreign Dow indexes, including correlations for various styles of investing. Information can be downloaded into Excel.

MSCI Barra [www.mscibarra.com] [cost: free] Morgan Stanley calculates over 100,000 equity, hedge fund and REIT indexes, including U.S. and foreign indexes. The MSCI tables show daily, monthly, quarterly and 1-10 year performance figures. The numbers reflect U.S. dollar and local currencies. Information can be downloaded into Excel.

Russell [www.russell.com] [cost: free] Daily, monthly, quarterly and annual equity returns for the U.S., Japan and Canada plus a number of other foreign indexes as well as the Russell 2000, the most widely used U.S. small cap index. Select periods and indexes can be downloaded.

Standard & Poor’s [www.standardandpoors.com] [cost: free] Extensive historical and current performance data for a wide range of U.S. and foreign S&P indexes. The site includes a FAQ section for each index.

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Wilshire Associates [www.wilshire.com] [cost: free] Wilshire has a number of proprietary indexes broken down by style and size. A built-in calculator displays returns for multiple indexes at the same time.

Mutual Funds and ETFs American Stock Exchange [www.amex.com] [cost: free] The site includes a number of statistics on each ETF, including price, expense ratio, performance, portfolio holdings and distributions. One section highlights ETFs that have reached new highs or lows. News articles on ETFs are ranked by date of publication.

There is also an educational section that includes a list of frequently asked questions (FAQs).

ETF Connect [www.etfconnect.com] [cost: free] This is one of the most comprehensive ETF sites. The advisor can search by ticker symbol, asset class, taxation or region. Hundreds of data points for each fund are included (e.g., dividend history, price, objectives, asset diversification, expense ratios and performance). SEC filings and links to news stories are also included. There is an educational section that provides answers to FAQs.

Morningstar [www.morningstar.com] [cost: free for 14 days; $160 year] Ratings for each fund covered by Morningstar plus over 150 statistics such as index and category comparisons. Paid subscribers can access reports on over 2,000 funds plus use different filters. The site includes an ETF screener based on eight criteria for over 800 ETFs. The ETF section also includes an ―ETF Quickrank‖ which places a fair value estimate on the fund. Mutual fund family reports cost $90 per year.

MSN Money [www.moneycentral.com] [cost: free] Access to over 12,500 mutual funds with over 200 data fields that can be used as filters or for comparison; includes past performance, management, risk and fund allocation. There are over 70 criteria that can be used to select funds for clients. The database includes return and risk data on over 800 ETFs.

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SmartMoney [www.smartmoney.com] [cost: free 14-day trial; $110 a year] Unlike other sites, this one uses information from Lipper and includes archived articles from Smart Money, published by The Wall Street Journal. Risk measurements, sector weightings, performance charts, fund ratios and Lipper ratings. Data on over 800 ETFs and screening of 50 criteria is included. The advisor can also review recent articles about ETFs.

Yahoo! Finance [www.finance.yahoo.com] [cost: free] Basic Morningstar data and screening on over 16,000 funds. The advisor can find out about management, risk levels and fund holdings. Advisor can compare and contrast performances of funds and indexes. E-mail account can be set up for automatic price alerts on any fund. Top-performing ETFs are also included.

Zacks [www.zacks.com] [cost: free] This site has extensive statistics on over 12,000 mutual funds plus screens that can be used by the advisor. The site offers over 150 data fields; up to 50 statistics can be used to compare one fund against another. The charting feature incorporates a Java-enabled custom analysis.

International ADR [www.adr.com] [cost: free] One of the best sites on ADRs; advisors can search by type, country, industry, ticker, name or exchange. Search results are displayed in a table that also displays financials and earnings expectations. International news and announcements help the advisor keep abreast of overseas markets.

BNY Mellon Depositary Receipts [www.adrbny.com] [cost: free] For ADRs maintained by Bank of New York Mellon, this is the site of choice. Advisors are also able to pull up information on other ADRs as well as holding company depositary receipts (HOLDRS). Summary tables include symbol, CUSIP, exchange conversion ratio, country of origin and date of last update. Links provide the advisory with additional sources of information.

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CIA World Factbook [www.odci.gov/cia/publications/factbook/inex.html] [cost: free] This site has links to the CIA‘s annual publication on foreign country data. The advisor can learn about every government, country and territory in the world. The economic review section covers GDP, labor, unemployment rate, budget, debt, currency and exports.

Euroland [www.euroland.com] [cost: free] Includes data on 25 European markets (e.g., charts, news, financial statements and currency converter). The advisor can create ―watchlists‖ and have the information presented in English or different European languages.

Site-By-Site [www.site-by-site.com] [cost: free] One of the best organized web sites for international markets. The included links cover news, economic data, central banks and commentary.

Bonds FINRA Bond Market Data [www.finra.org/marketdata.com] [cost: free] The Financial Industry Regulatory Authority (FINRA) provides real-time quotes on corporate bonds based on recently reported trades (e.g., price, credit rating, quantity, yield, 90 days of trading history and one year of weekly highs and lows. Whether or not a commission was charged is also included. The advisor can track up to 100 different issues at a time. A separate section provides education on bonds, bond investing and bond trading.

InvestinginBonds [www.investinginbonds.com] [cost: free] This site is designed for the individual investor. Strategies, real-time pricing and educational information on corporate and municipal bonds is included. Corporates and municipals that have traded more than four times the previous day are shown, along with their history and number of trades. Advisors will find the ―benchmark spread‖ of particular interest.

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TreasuryDirect [www.treasurydirect.gov] [cost: free] For advisors dealing in U.S. Treasury securities, including TIPS and savings bonds, this site allows on-line commission-free purchases government direct. The client can also set up an directly that allows for interest reinvestment and the sale of the securities before maturity. There is extensive coverage of all forms of savings bonds, tax features and current rates for new issues.

REITs REITs [www.reit.com] [cost: free] This site, sponsored by the real estate investment trust (REIT) trade group, NAREIT, is for the individual investor and advisor. Anyone can access index and individual REIT returns and make comparisons to other REITs in the same sector. A separate listing of REITs within S&P indexes, REITs with dividend reinvestment programs, stock purchase plans, REIT mutual funds, REIT closed-end funds, REIT ETFs and registered but nonexchange-traded REITs are included. The advisor can also view a map to see which REITs have properties in a specific state. The directory only includes NAREIT members.

There are extensive features for education, including articles and brochures.

REITcafe [www.reitcafe.com] [cost: free] A sponsor-supported site offers podcasts and conference calls with REIT executives and analysts. Regulatory commentary plus news on REITs and the industry are included. The advisor can also access statistics on REIT indexes, volatility and index correlation graphs.

A weekly newsletter is available at no cost.

Personal Finance Bankrate.com [www.bankrate.com] [cost: free] This site focuses on current interest rates for mortgages, bank CDs, credit cards, personal loans and fixed-income products. A number of finance calculators are included to decide things such as whether mortgage financing is a good idea or how much should be saved for a child‘s education.

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CNN/Money [www.money.cnn.com] [cost: free] The advisor or individual investor can access a large number of articles on financial and retirement planning, educational accounts, taxes, banking, loans and insurance. The site provides for a comparison of home loans, mortgages and bank CDs.

MSN Money [www.moneycentral.msn.com] [cost: free] Virtually every aspect of financial planning is covered for the novice. The investor can also access finance calculators and articles.

SmartMoney [www.smartmoney.com] [cost: 14-day free trial; $110 year] Designed for the individual investor, this site has an in-depth library of articles on all aspects of personal financial planning. There is also extensive coverage about small businesses, health care and elder issues. Your client can also compare products.

Yahoo! Finance [www.finance.yahoo.com] [cost: 30-day free trial; $130 year] This site is designed for the individual investor and includes a large number of ―how to‖ articles. Links to tools, calculators, product comparisons, banking, loans, insurance and taxes are also featured.

Retirement Planning T. Rowe Price [www.troweprice.com] [cost: free] The advisor can help a client decide a number of retirement issues (e.g., whether a given level of income is likely to last until death). The site concentrates on using qualified retirement accounts and IRAs. The ―Retirement Income Calculator‖ is excellent but limited in its flexibility.

Vanguard [www.vanguard.com] [cost: free] The ―Lifetime Spending Analyzer‖ simulates a number of historical markets to determine whether or not a specified income stream can be maintained throughout retirement. The site includes a number of well-written articles and worksheets on retirement planning.

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Estate Planning Financial Planning Toolkit [www.finance.cch.com] [cost: free] A technical and complex approach to every aspect of estate planning that is sponsored by Commerce Clearing House, a well-known provider of tax and legal information for advisors, lawyers, accountants and other professionals.

Crash Course in Wills and Trusts [www.mtpalermo.com] [cost: free] Estate planning attorney Michael T. Palermo provides an easy-to-understand but detailed explanation as to what everyone should know about wills, trusts and estate planning.

Nolo Press [www.nolo.com] [cost: free] The layperson can find articles written by Nolo about estate planning, wills, trusts, taxation and probate issues.

Tax Information H&R Block [www.hrblock.com] [cost: free] This site provides tips on how to reduce taxes. H&R Block also publishes tax preparation software, TaxCut.

Internal Revenue Service [www.irs.gov] [cost: free] The advisor can download IRS tax forms and instructions. Almost every issue on taxation is covered and most of the information is easy to understand. There is also a FAQ section and instructions on how to file electronically.

Sister States Tax Directory [www.sisterstates.gov] [cost: free] This is an excellent one-stop source that links the user to tax forms, information and publications for all 50 states.

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TurboTax [www.turbotax.com] [cost: free] This tax preparation site provides an explanation of a wide range of tax issues and strategies. The site‘s sponsor also publishes the most popular tax preparation software in the nation, TurboTax.

Insurance Products Insurance Information Institute [www.iii.org] [cost: free] This is an industry-sponsored source, allowing the advisor to search for companies in his or her state. The site includes consumer web videos on life insurance and annuities.

Insure.com [www.insure.org] [cost: free] A consumer-oriented site that provides insurance quotes plus ratings from A.M. Best, S&P, Moody‘s and Fitch. There is a separate section on long-term care and annuities.

Life insurance needs can be estimated; an explanation of the tax consequences of surrenders, loans and early payouts are also discussed.

Katt & Company [www.peterkatt.com] [cost: free] This site is sponsored by a fee-only life insurance advisor; his library includes detailed articles written for advisors and consumers.

LIFE [www.lifehappens.org] [cost: free] The non-profit organization, Life and Health Insurance Foundation for Education, describes the basics of life insurance and can help the consumer decide between term and whole life. A ―care map‖ shows average daily nursing home costs for each state. Online videos explaining insurance basics are also available.

Lifeinsurance [www.lifeinsure.com] [cost: free] The advisor can obtain several life insurance quotes without providing personal information. This quote service explains how premium rates are calculated. A blog and video section discusses life insurance and recent news.

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NAIC [www.naic.org] [cost: free] The National Association of Insurance Commissioners (NAIC) is the organization of state insurance regulators. The advisor is able to find information about life insurance, long-term care and annuities for a specific state. Some of the publications can be downloaded while other brochures can be ordered (e.g., The Life Insurance Buyer’s Guide, A Shopper’s Guide to Long-Term Care Insurance and Buyer’s Guide to Fixed Deferred Annuities).

Federal Government Federal Deposit Insurance Corporation [www.fdic.gov] [cost: free] Detailed information about FDIC coverage and what to do if a bank fails.

FedStats [www.fedstats.gov] [cost: free] This is a link to over 100 federal agencies, covering a wide range of topics such as population trends, health care costs and foreign trade.

Pension Benefit Guaranty Corporation (PBGC) [www.pbgc.gov] [cost: free] A federal government agency provides protection to qualified defined benefit plans. If a defined benefit plan fails, PBGC takes over the administration of the plan and provides a minimum payment schedule for the plan‘s participants. The advisor can also find out if a specific plan is covered by PBGC.

Social Security Online [www.ssa.gov] [cost: free] The Social Security website provides detailed information on all Social Security programs and benefits (e.g., how to apply for benefits, benefit levels, etc.).

U.S. Department of Labor [www.dol.gov/ebsa] [cost: free] The Department of Labor‘s web site on pension plans, including participant rights and what to do if the employer goes bankrupt.

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U.S. Securities and Exchange Commission (SEC) [www.sec.gov] [cost: free] The government‘s online source for filing required securities reporting, including mutual fund reports and filings. A mutual fund‘s annual report, 10-K and prospectus can be retrieved from this site. One of the site‘s links allows consumers to check on individual brokers, brokerage firms and investment advisors.

Economic Data Bureau of Economic Analysis [www.bea.gov] [cost: free] The advisor can obtain articles and analysis on the U.S. economy on either a national, regional or industry group basis. Current economic news from around the world is included.

Federal Reserve [www.federalreserve.gov] [cost: free] Each of the 12 Federal Reserve district banks has their own proprietary collection of data, articles and analysis. The St. Louis district bank board maintains the primary database for the Federal Reserve board. The emphasis of this site is monetary policy.

FreeLunch [www.economy.com/freelunch.com] [cost: free] An economic and financial database sponsored by Moody‘s. The information can be downloaded directly into Microsoft Excel.

FDIC CONCERNS Due to the expected waive of bank failures, the Federal Deposit Insurance Corporation (FDIC) may have to borrow money from the U.S. Treasury. The last time FDIC borrowed money from the Treasury was in the early 1990s during the end of the savingsand-loan crisis after thousands of banks closed.

As of the end of August 2008, there were 117 banks that were on FDIC‘s ―problem‖ list.

The FDIC‘s deposit insurance fund dropped to $45.2 billion during the second quarter of 2008, a figure that represents just 1.01% of all insured deposits. The FDIC was created during the Great Depression.

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TAXABLE FIXED-INCOME ALLOCATION From the end of 1995 to the end of 2004, $10,000 invested in a diversified portfolio of bonds (1/3rd med-term Treasuries, 1/3rd investment-grade corporates and 1/3rd in GNMAs—an overall mix that is somewhat similar to the LB Aggregate Bond Index) grew to $20,000. The same $10,000 invested just in investment-grade corporates grew to $17,500 and $16,500 in the case of intermediate-term Treasuries. The table below shows one approach to structuring the taxable fixed-income portion of a portfolio.

Taxable Fixed-Income Allocation Allocation 50% 20% 20% 10%

Category LB Aggregate Bond Index TIPS or iBonds High-Yield Corporates Emerging Market Debt

BOOKS ON “MUST READ” LISTS The chairperson of Bedford Oak Partners once said, ―Put all of Warren Buffet‘s annual stockholder letters together and you probably have the greatest book on investing ever written.‖ In fact, you can access these annual letters since 1977 by going to BerkshireHathaway.com. The table below lists 20 books that appear on most financial writers‘ and managers‘ ―must read‖ lists.

20 Well-Respected Books On Investing Against the Gods

by Peter Bernstein Annual Letters to Stockholders

by Warren Buffett The Battle for the Soul of Capitalism

by John Bogle Beating the Street

by Peter Lynch and John Rothchild The Coffeehouse Investor

The Informed Investor

by Frank Armstrong The Intelligent Investor

by Benjamin Graham The Little Book That Beats the Market

by Joel Greenblatt The Only Guide to a Winning…

by Larry Swedroe The Only Investment Guide…

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by Bill Schultheis Contrarian Investment Strategy

by David Dreman The Essays of Warren Buffett

by Warren Buffet Fooled by Randomness

by Nassim Nicholas Taleb The Four Pillars of Investing

by William Bernstein The Future for Investors

by Jeremy Siegel

2.14

by Andrew Tobias A Random Walk Down Wall Street

by Burton Malkiel Stocks for the Long Run

by Jeremy Siegel Unconventional Success

by David Swensen Winning on Wall Street

by Marty Zweig Winning the Loser’s Game

by Charles Ellis

WORDS OF WISDOM                     

Emotion always trumps reason.

One cannot overstate the role of luck when it comes to investing.

Someone smarter will always have a view opposite yours.

The market always has the last word.

Negatives about an investment are usually given too little attention.

Entrenched trends tend to last longer and deeper than anticipated.

Virtually everything good about the market is the result of time.

Self-confidence is a sign of inexperience; humility is a sign of wisdom.

The purchase price is more important than what you bought.

In an overvalued market, a sell-off is needed to resume its upward trend.

Humans tend to forget past mistakes; this enables gurus to gain recognition.

Losses are inevitable; taking big losses is unacceptable—use stops.

Accept the fact that a stock will always go down when you buy it.

A stock usually goes up after you sell it.

Hold onto the winners and weed out the losers.

The only way to prevail against market professionals is to invest long term.

Humans are not emotionally wired for success.

Traders give up a huge advantage: the market‘s long-term upward bias.

The emotional component of a stock is hard to measure but easily ignored.

The color of the market is grey, not black or white.

The best investment advice is ―stay healthy.‖ QUARTERLY UPDATES

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FINANCIAL PLANNING

2.15

QUOTES ABOUT INVESTING  ―The truth is independent of how many people believe it.‖ — Anonymous  ―I have been covering personal finance for two decades and I am continually amazed by how little I know. My advice: develop a sense of conviction about your profound ignorance. You probably won‘t have time to wait very long for confirmation.‖ — Jonathan Clements  ―Making money is hard if you wait till situations are clear to everyone. We are often better served by quick analysis that‘s 80% right than by slow analysis that is 95% right.‖ — Jim Oberweis  ―A good technician gets it right maybe 60% of the time, and a great technician, maybe 61% of the time.‖ — Gary B. Smith  ―One lesson I‘ve learned over the years is that mutual fund investors almost always do significantly worse than the funds they own. That lesson is likely to be repeated in ETFs.‖ — John Bogle  ―When you lose, don‘t lose the lesson.‖ — Charles Kirk  ―Human beings are hardwired to be massively irrational when it comes to financial matters…Even the most brilliant investors only have a few good ideas a year.‖ — Whitney Tilson  ―Good judgment comes from experience, and experience comes from bad judgment.‖ — Dr. Steven Cramer  ―Saving money on a regular basis is the key to financial success. It‘s so simply— and yet so few people do it.‖ — Jonathan Clements  ―Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.‖ — Michael B. Steele  ―The stock market is filled with individuals who know the price of everything but the value of nothing.‖ — Philip Fisher  ―New opinions are always suspected and usually opposed, without any other reason but because they are not common.‖ — John Locke

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FINANCIAL PLANNING

2.16

 ―Rule #1: Never lose money. Rule #2: Never forget rule #1.‖ — Warren Buffett  ―By definition, most people are part of the consensus. But on Wall Street, no one wants to admit it.‖ — Michael Santoli  ―A bull market may be defined as an upward movement in prices causing an investor to mistake himself for a financial genius.‖ — Unknown  ―On average, America‘s millionaires go out of business or bankrupt 3.5 times before they reach their goal.‖ — Unknown  ―Be extremely skeptical and stay with what you know. The great success stories in life are people who figure out what they know, stay with it, put their eggs in that basket and watch it very carefully.‖ — Jim Rogers  ―Unpopular stocks tend to do better than popular ones because equities advance by exceeding expectations. Lower expectations are easier to exceed.‖ — John Dorfman  ―The only way to beat the market is not to look like the market.‖ — Larry Swedroe  ―Stock market returns show a strong tendency to revert to the mean—and that mean, over the long run, is up.‖ — Burton Malkiel  ―For every transaction there is a buyer and seller. Each one thinks he/she is dead right.‖ — Unknown  ―Markets can remain illogical longer than you or I can remain solvent.‖ — Gary Shilling  ―The general investment knowledge of the masses an be written large on the head of a pin.‖ — Phil De Muth  ―The investor‘s only real effective, dependable weapon against the equally dependable perversity of the market is time, and lots of it.‖ — Unknown  ―Buy a business any fool can manage, because eventually one will.‖ — Warren Buffett

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2.17

 ―It‘s just not true that you can‘t beat the market. Every year about one-third of the fund managers do it. Of course, each year it is a different group.‖ — Robert Stovall  ―The stock market is the only place where the customer will run away from a bargain.‖ — Unknown  ―If you want to see the greatest threat to your financial future, go home and take a look in the mirror.‖ — Jonathan Clements  ―When everyone thinks a company is going to strike out, you just need a single to do okay.‖ — Richard Bernstein  ―Reversion to the long-term mean is one of the iron-clad rules of financial markets.‖ — James O. Shaughnessy  ―Corporate management infrequently, if ever, view their long-term prospects with suspicion.‖ — Doug Kass  ―The essence of investment theory is that being smart is not a sufficient condition for being rich.‖ — Peter Bernstein  ―When asked what he considered man‘s greatest discovery, Albert Einstein replied without hesitation, ‗compound interest.‘‖ — Charles Ellis  ―This message [that attempting to beat the market is futile] can never be sold on Wall Street because it is, in effect, telling stock analysts to drop dead.‖ — Paul Sammuelson, Nobel Laureate in Economics  ―The biggest mistake in investing is believing the last three years is representative of what the next three years is going to be like.‖ — Ray Dalio

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MUTUAL FUNDS

3.HEDGE

3.1

FUNDS

For advisors interested in hedge funds, the table below lists some of the largest players in the industry (note: fund size in billions, shown in parentheses).

Large Hedge Funds [August 2008]  Brevan Howard ($26b)

 Goldman Sachs ($27b)

 Bridgewater Associates ($31b)  J.P. Morgan/Highbridge ($49b)  D.E. Shaw & Co. ($37b)

 Och-Ziff Capital ($33b)

 Farallon Capital ($33b)

 Paulson & Co. ($35b)

 GLG Partners ($24b)

 Renaissance Technologies ($30b)

HARVARD’S ENDOWMENT FUND Harvard Management Company, which oversees the $37 billion Harvard Endowment Fund, returned 8.6% for its 2008 fiscal year that ended June 30th (vs. -15% for the S&P 500 during the same 12-month period). The endowment said that it outperformed 95% of the 165 large institutional funds that the trust sector measures. More importantly, the endowment fund has averaged about 13% for the past five years and approximately 12% per year over the past 10 years (note: both these figures include the 2007 fiscal year but not returns for its 2008 fiscal year). The fund invests in 11 noncash asset classes, U.S. stocks being just one. Harvard currently allocates about 33% to real assets such as commodities and real estate. Last year, about 12% of the portfolio was invested in U.S. stocks, 10% in foreign equities, 8% in emerging markets stocks, 11% in private equity, 10% in fixed income, 18% in hedge funds and 31% in real assets.

The first table below shows return figures generated by the endowment fund for different periods (source: Harvard Management Co.). Harvard believes in active management, as shown by the ―Benchmark‖ figures that show what returns would have been if passive (index) portfolios were used.

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3.2

Annualized Returns [includes 2007 fiscal year] Harvard vs. Benchmark of Similar Large Endowments Harvard (5 years)

Benchmark Harvard Benchmark (5 years) (10 years) (10 years)

EQUITIES U.S.

13.1%

11.3%

11.6%

8.4%

Foreign

19.8%

18.5%

11.3%

8.4%

Emerging Markets

32.0%

30.9%

14.6%

13.7%

Private

20.0%

16.4%

30.6%

14.0%

U.S.

14.5%

5.2%

13.7%

6.8%

Foreign

16.9%

6.8%

13.3%

4.9%

High-Yield

18.1%

13.8%

9.8%

4.9%

Commodities

17.4%

9.2%

12.4%

6.2%

Real Estate

21.1%

15.7%

17.3%

15.1%

TIPS

6.2%

6.3%

n/a

n/a

Special situations

15.0%

11.0%

n/a

n/a

Annualized

18.4%

13.8%

15.0%

10.5%

Median for large endowments

11.6%

FIXED INCOME

REAL ASSETS

8.4%

According to the endowment fund, Harvard has used a ―variety of alpha generators to add value. Examples include absolute return strategies, including equity and fixed income arbitrage, beta exposure management (e.g., timber), enhanced cash management, structural alpha trades and tactical adjustments to asset allocation.‖ Harvard combines bottom-up and top-down assessments. Historically, roughly two-thirds of its returns have been due to its asset allocation policy (what asset classes and how much per category). In order of weighting (highest to lowest), Harvard Management Company has the following neutral asset allocation:

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MUTUAL FUNDS

3.3

Harvard’s Neutral Non-Cash Asset Allocation [approximate weighting shown in parentheses] Asset Category

Asset Category

U.S. Equities (17%)

Emerging Markets (8%)

Foreign Equities (17%)

Inflation-Indexed Bonds (7%)

Commodities (14%)

U.S. Bonds (6%)

Absolute Return (11%

Real Estate (6%)

Private Equities (9%)

Foreign Bonds (3%) High-Yield Bonds (2%)

Harvard Endowment Fund Annualized Returns [1974-2006] 1974-1984

1985-1995

1996-2006

1974-2006

10.4%

12.7%

15.0%

13.5%

MONEY MARKET FUND HISTORY Before the advent of the money market fund by Henry B.R. Brown in the early 1970s, the Federal Reserve Board‘s Regulation Q capped interest rates; only investors with $100,000 or more could get a higher rate. Regulation Q was phased out in 1986. The spread for banks was sometimes in excess of five percentage points (e.g., pay depositors 4% and lend out the money at 9%+).

Before Brown could start his money market fund, he had to research banking regulations in all 50 states and learn how to program time-sharing computers to handle the interest calculations. His Reserve Fund, Inc. was opened in 1972; today it manages over $130 billion (and is now called ―The Reserve‖). The fund attracted little money until a January 1973 article in the Sunday New York Times. The article pointed out that the fund was designed for institutions and investment counselors but it was also open to individual investors. By the end of 1973, the fund was managing $100 million (and investors were receiving 9%).

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RETIREMENT

4.SOCIAL

4.1

SECURITY PAYBACK STRATEGY

Any of your clients who have received Social Security retirement benefits can file a request to stop such benefits, file a new application for benefits and pay back the amounts already received. Based on the client‘s now older age, bigger checks will be received.

The risk of utilizing this strategy is that Social Security is paid back and then the recipient dies before recouping the amount paid back in the form of larger checks. How the checks are repaid is also an important consideration. For example, if qualified retirement accounts or a traditional IRA is being liquidated, the tax ramifications need to be considered since the cost of repayment would be increased. A Boston University economist reviewed the strategy by assuming that the money used to pay back Social Security came from conservative investments that were inflation hedged (go to ESPlanner.com, click on ―Case Studies‖ and then click on ―Double Dip on Social Security‖).

For example, a married couple, both age 70, started to receive Social Security retirement benefits in their early 60s; each spouse will receive $13,250 for 2008. However, had the couple waited and began to receive benefits in 2008, each would receive $20,693 for 2008, a 56% increase.

In order to payback Social Security benefits and begin at a now older age, your client will need to file Social Security Form 521, ―Request for Withdrawal of Application.‖ The amount sent back to Social Security is calculated by totaling up all retirement benefits received so far; there is no adjustment for inflation or any interest rate charge. Your client may also be able to recover any federal income taxes paid on such benefits (see page 15 of IRS Publication 915). In the year of repayment, the client can choose to receive either a tax credit or an itemized deduction. The tax benefit is based on recalculating past years‘ tax bills as if there had been no Social Security retirement benefits. If your client temporarily stops receiving benefits, so does their spouse if the spousal benefits were based on the client‘s earnings. Social Security will send your client a letter explaining the amount that will have to be paid back (which would include spousal benefits) before the new, bigger benefit begins.

REVERSE MORTGAGE LEGISLATION Proposed legislation on reverse mortgages will consider the following: [1] a $417,000 national limit for HECM loans, [2] use of the home equity conversion mortgage (HECM) as a purchase note, [3] ability to use HECM loans for co-op properties and [4] a statutory maximum origination fee of 1.5%.

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STOCKS

5.1

5.BERKSHIRE

HATHAWAY PORTFOLIO

As of April 2007, the top four stocks of Berkshire Hathaway, KO, AXP, WFC and PG represented over 50% of its portfolio. The table below shows Berkshire‘s top 10 holdings.

Top 10 Holdings of Berkshire Hathaway [April 2007]  Coca-Cola (KO)

 Johnson & Johnson (JNJ)

 American Express (AXP)

 Burlington Northern (BNI)

 Wells Fargo (WFC)

 Wesco Financial (WSC)

 Procter & Gamble (PG)

 Tesco (PLC)

 Moody‘s (MCO)

 Anheuser-Busch (BUD)

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INDEX INVESTING

6.PASSIVE

6.1

INVESTING

Albert Einstein once wrote, ―If we knew what we were doing, it wouldn‘t be called research.‖ Charles Schwab has stated that 75% of the mutual funds he owns are index funds. A February 2006 MarketWatch.com column stated that the S&P 500 beat 97% of mutual fund managers for the 10-year period ending October 2004. Two studies covering 30-year periods found that the S&P 500 outperformed 97% and 94% of active equity fund managers. The reason for such failure is both psychological and financial (fees and trading costs). A Dalbar study covering a 20-year period showed that the typical equity fund investor averaged 2.5% a year while the S&P 500 averaged 12.2% annually. The main reason for this disparity is that stock investors buy high and sell low. Some Internet sites that cover index funds and ETFs are shown in the table below.

Internet Index Fund and ETF Sites  Amex.com

 ETFdigest.com

 Indexfunds.com

 BillCara.com

 ETFexpert.com

 Indexinvestor.com

 DFAus.com

 ETFguide.com

 Indexuniverse.com

 ETF-reader.com

 ETFscreen.com

 iShares.com

 ETF.seekingalpha.com

 Fool.com

 JournalofIndexes.com

 ETF central.com

 IFA.com

 Nasdaq.com

 ETFconnect.com

 Indexchange.com

 XTF.com

Rebalancing The Wall Street Journal columnist Jonathan Clements wrote, ―If a market segment is bouncing back after a rotten stretch, don‘t rebalance every year. Instead, hold off for 2-3 years so you can capture more of the rebound.‖ Former head of Vanguard John Bogle conducted two studies on rebalancing, one going back 20 years and one going back to 1826. In both cases, Bogle concluded that the difference between rebalancing and not rebalancing was minor. On the other hand, the author of the book, All About Asset Allocation writes, ―By taking some money out of things that did well and putting it into things that were down, you‘ll pick up 1% more on your equity portfolio per year over the long term. That‘s a good deal.‖

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6.2

Asset Classes for Risk Reduction Whether or not you allocate 15% or 30% of a client‘s portfolio to a broad category such as international stocks will probably make little difference over the next 20-30 years.

What will make a difference is your commitment to stick to the target percentage you have selected. Richard Ferri, the author of All About Asset Allocation, summarizes his book as follows: ―You have a little bit everywhere and once a year, on your birthday or after New Year‘s, you rebalance your portfolio. You get it back to your original targets.

Correlations fluctuate. You don‘t know what‘s going to happen to energy, to tech, to bonds, to emerging markets. You do know that in the long run everything regresses to the mean over your lifetime.‖ Ferri found that three segments of the market were especially effective in reducing risk and increasing long-term returns: small cap value stocks, micro cap stocks and REITs. Ferri believes that these are three asset classes that deviate substantially from the performance of the total stock market and make a portfolio more efficient. Robert Arnott, manager of the Pimco All Asset Fund (PASAX), in an April 2007 interview was asked what assets are best for diversifying a traditional stock and bond portfolio. His response was: commodities, TIPS and international bonds.

SCOTT BURNS: COACH POTATO PORTFOLIO Retired in 2006, Scott Burns was the financial editor of the Dallas Morning News for 21 years and the Boston Herald before that. For the past 31+ years, Scott has written a weekly nationally syndicated column on investing and personal finance. Burns (scottburns.com) founded the Coach Potato Portfolio in 1991 using just two index funds, one based on the S&P 500 (50%) and the other based on the Total Bond Market Index (50%). He later replaced both funds with a Total Market Index fund and a TIPS bond index fund. He recommends annual rebalancing. For younger, more aggressive investors, Burns suggests using the same two funds.

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6.3

Coach Potato Portfolio Weighting

Fund (symbol)

50%

Vanguard Total Stock Market Index Fund (VTSMX)

50%

Vanguard Inflation-Protected Securities Fund (VIPSX)

During the early part of 2004, Burns started the ―Margarita Portfolio‖ in honor of Jimmy Buffet. Like the drink, it is made with three equal parts. During the past few years, Burns has added a few more portfolios, confessing that a more diversified portfolio is likely to produce higher risk-adjusted returns.

Margarita Portfolio Weighting

Fund (symbol)

33.3%

Vanguard Total Stock Market Index Fund (VTSMX)

33.3%

Vanguard Inflation-Protected Securities Fund (VIPSX)

33.3%

Vanguard Total International Stock Index Fund (VGTSX)

Four Square Portfolio Weighting

Fund (symbol)

25%

Vanguard Total Stock Market Index Fund (VTSMX)

25%

Vanguard Inflation-Protected Securities Fund (VIPSX)

25%

Vanguard Total International Stock Index Fund (VGTSX)

25%

American Century International Bond Fund (BEGBX)

Five Fold Portfolio Weighting

Fund (symbol)

20%

Vanguard Total Stock Market Index Fund (VTSMX)

20%

Vanguard Inflation-Protected Securities Fund (VIPSX)

20%

Vanguard Total International Stock Index Fund (VGTSX)

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6.4

20%

Vanguard REIT Index Fund (VGSIX)

20%

American Century International Bond Fund (BEGBX)

Six Ways From Sunday Portfolio Weighting

Fund (symbol)

16.65%

Vanguard Total Stock Market Index Fund (VTSMX)

16.65%

Vanguard Inflation-Protected Securities Fund (VIPSX)

16.65%

Vanguard Total International Stock Index Fund (VGTSX)

16.65%

Vanguard REIT Index Fund (VGSIX)

16.65%

American Century International Bond Fund (BEGBX)

16.65%

Vanguard Energy Fund (VGENX)

BILL SCHULTHEIS: COFFEEHOUSE PORTFOLIO Bill created the ―Coffeehouse Portfolio‖ in his 1998 book, The Coffeehouse Investor. The book was revised in 2005. This index fund portfolio is 40% in an intermediate-term bond index fund and 60% in stocks, equally divided into the following six categories: large cap, large cap value, small cap, small cap value, international and real estate.

Bill Schulthesis’ Three ETF Fund Portfolio Weighting

Fund (symbol)

33.3%

Vanguard Total Stock Market (VTI)

33.3%

iShares International MSCI EAFE Value (EFV)

33.3%

iShares Lehman Aggregate Bond (AGG)

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6.5

Coffeehouse Portfolio Weighting

Fund (symbol)

40%

Vanguard Total Bond Index Fund (VBMFX)

10%

Vanguard 500 Index Fund (VFINX)

10%

Vanguard Value Index Fund (VIVAX)

10%

Vanguard Small Cap Index Fund (NAESX)

10%

Vanguard Small Cap Value Index Fund (VISVX)

10%

Vanguard Total International Stock Index Fund (VGTSX)

10%

Vanguard REIT Index Fund (VGSIX)

Alternate Coffeehouse Portfolio Using ETFs Weighting

Fund (symbol)

40%

iShares Lehman Aggregate (AGG)

10%

iShares S&P 500 (IVV)

10%

iShares S&P 500/Barra Value (IVE)

10%

iShares Morningstar Small Core (JKJ)

10%

iShares Russell 2000 Value (IWN)

10%

iShares MSCI EAFE (EFA)

10%

iShares Lehman Dow Jones U.S. Real Estate (IYR)

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6.6

WILLIAM J. BERNSTEIN: NO-BRAINER PORTFOLIO Dr. Bernstein, age 60, is a doctor turned investment advisor and writer. He has written three books: The Four Pillars of Investing (2002), The Intelligent Asset Allocator (2000) and The Birth of Plenty (2004); all published by McGraw-Hill. The Four Pillars of Investing has been widely quoted in a number of publications, including The Wall Street Journal. Bernstein favors low-cost mutual funds over ETFs. The equity portion of his model portfolios is tilted toward value; the bond portion is high quality and short term (five years or less).

According to Bernstein (www.efficientfrontier.com), ―If over the past 10-20 years, you had simply held a portfolio consisting of one quarter each of indexes of large U.S. stocks, small U.S. stocks, foreign stocks and high-quality U.S. bonds, you would have beaten over 90% of all professional money managers with considerably less risk.‖ He believes that by rebalancing once a year, portfolio return can be enhanced by ½-1% per year over time. Bernstein believes that ―99% of fund managers demonstrate no evidence of skill whatsoever.‖

Basic No-Brainer Portfolio Weighting

Fund (symbol)

25%

Vanguard 500 Index Fund (VFINX)

25%

Vanguard Small Cap Index Fund (NAESX)

25%

Vanguard Total International Stock Index Fund (VGTSX)

25%

Vanguard Total Bond Index Fund (VBMFX)

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6.7

No-Brainer Coward’s Portfolio Weighting

Fund (symbol)

40%

Vanguard (VFTSX)

Short

Term

Investment

Grade

Fund

15%

Vanguard Total Stock Market (VTSMX)

10%

Vanguard Value Index Fund (VIVAX)

10%

Vanguard Small Cap Index Fund (VISVX)

5%

Vanguard Small Cap Value Index Fund (NAESX)

5%

Vanguard REIT Index (VGSIX)

5%

Vanguard European Stock (VEURX)

5%

Vanguard Pacific Stock (VPACX)

5%

Vanguard Emerging Markets Stock (VEIEX)

TED ARONSON PORTFOLIO Ted Aronson oversees a value-oriented company that manages $27 billion in tax-exempt institutional funds. Mr. Aronson also manages two mutual funds, Quaker Small-Cap Value Fund I (QSVIX) and HighMark Large-Cap Value Fund (HMIEX); he and his partners have most of their own retirement money in these two funds. Aronson has 100% of his mother‘s taxable accounts in Vanguard index funds. His family‘s money is invested in 11 Vanguard index funds (see table below).

TheStreet.com has called Aronson, ―the world‘s most honest money manager.‖ MarketWatch.com has written, ―He doesn‘t sell or trade, he just keeps adding new money to rebalance and maintain the designated asset allocation. Aronson is a brilliant fund manager with a reputation for absolute integrity.‖ For additional information about his portfolio (shown below), go to MarketWatch.com and look for Aronson‘s interview with Jonathan Burton (―Matchless Match,‖ January 3rd, 2007).

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6.8

Ted Aronson Portfolio Weighting

Fund (symbol) U.S. Stocks (40%)

5%

Vanguard Total Stock Market (VTSMX)

15%

Vanguard 500 Index (VFINX)

10%

Vanguard Extended Market Index (VEXMX)

5%

Vanguard Small Cap Growth Index (VISGX)

5%

Vanguard Small Cap Value Index (VISVX) Foreign Stocks (40%)

20%

Vanguard Emerging Markets Stock (VEIEX)

15%

Vanguard Pacific Stock Index (VPACX)

5%

Vanguard European Stock Index (VEURX) Domestic Bonds (20%)

10%

Vanguard Inflation-Protected Securities (VIPSX)

5%

Vanguard High Yield Corporate (VWEHX)

5%

Vanguard Long Term Treasury (VUSTX)

DAVID SWENSEN PORTFOLIO David Swensen, age 53, has been a manager of Yale‘s $20+ billion endowment fund for a number of years. He has been the chief investment officer for Yale since 1985. Prior to working for Yale, Swensen worked for six years at Salomon Brothers and Lehman Brothers. During the first 16 years of his stewardship at Yale, he averaged over 16% a year. In a 2005 article, the New York Times called him ―the best manager of institutional money in the U.S.‖ Vanguard founder John Bogle calls Swensen an ―investment genius‖ and a former manager of Harvard‘s endowment fund said, ―I think David is the best in the business.‖

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6.9

A good portion of Swensen‘s success has been from the use of alternative investments such as oil and gas, real estate, timberland, private equity, exotic foreign securities and hedge funds. He believes in ongoing portfolio rebalancing. David is also the inventor of the ―The Yale Model,‖ an approach to multi-asset class investing that is used around the world. In 2005 he wrote a book, Unconventional Success published by Free Press (note: the portfolio below comes directly from this book).

David Swensen Portfolio Weighting

Fund (symbol) U.S. Stocks (50%)

30%

Vanguard Total Stock Market Index (VTSMX)

20%

Vanguard REIT Index (VGSIX) Foreign Stocks (20%)

15%

Vanguard Developed Markets Index (VDMIX)

5%

Vanguard Emerging Markets Stock Index (VEIEX) Domestic Bonds (30%)

15%

Vanguard Short Term Treasury Index (VFISX)

15%

Vanguard Inflation-Protected Securities (VIPSX)

BEN STEIN’S LONG-TERM PORTFOLIO Ben‘s father, economist Herbert Stein, was chairperson of the Council of Economic Advisors for Presidents Nixon and Ford. Ben has authored 25 books, mostly on personal financial (benstein.com). Ben Stein believes that investors should all use index funds.

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6.10

Ben Stein’s Long-Term Portfolio Weighting 15-25%

Fund (symbol) iShares MSCI EAFE Index (EFA)

10%

iShares MSCI Emerging Markets Index (EEM)

30%

Fidelity Spartan Total Market Index (FSTMX)

10%

iShares Cohen & Steers Realty Majors (ICF)

10%

iShares Russell 2000 Value Index (JWN)

15%

Cash

Stein is a huge advocate of high-dividend stocks for retirement accounts. According to Stein, ―Long-term studies show that over lengthy periods, high-dividend stocks have better total return than either low- or no-dividend stocks, or the broad market generally.‖ After doing quite a bit of testing, Stein has concluded that for someone who lives 30 years after retirement withdrawing 4-5% annually, the two-fund portfolio below would have almost no risk of running out of money—the nest egg should actually multiply substantially (see his January 2006 column on Finance.Yahoo.com, ―A Retirement Portfolio With Staying Power‖).

Ben Stein’s Two-Fund Retirement Portfolio With Staying Power Weighting

Fund (symbol)

50%

StreetTRACKS Wilshire REIT (RWR)

50%

iShares Dow Jones Select Dividend (DVY)

QUARTERLY UPDATES

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6.11

AMERICAN ASSOCIATION OF INDIVIDUAL INVESTORS James Cloonan, age 78, founded the American Association of Individual Investors (AAII) in 1978. AAII has over 150,000 subscribers and its magazine does not accept advertising. The portfolio below includes an ―optional‖ ETF to help control risk, iShares Lehman 1-3 Year Treasury Bonds (SHY).

AAII Model Portfolio Weighting

Fund (symbol)

20%

First Trust Dow Jones Select Micro Cap Index (FDM)

20%

Power Shares FTSE RAFI US 1000 (PRF)

20%

Rydex S&P Mid Cap 400 Pure Value (RFV)

20%

Rydex S&P Small Cap 600 Pure Value (RZV)

20%

iShares Cohen & Steers Realty (ICF)

BARTON MALKIEL Barton, age 77, is a nationally recognized Princeton professor who is best known as a strong advocate of the efficient market hypothesis (EMH). His background includes being a member of the President‘s Council of Economic Advisors and dean of the Yale School of Management. Mr. Malkiel is the author of the very popular book, A Random Walk Down Wall Street. His basic premise about investing has not changed over the past 30 years. According to Barton, ―If an investor is to buy only one U.S. index fund, the best is the Dow Wilshire 5000 stock index (WFIVX), not the S&P 500,‖ which he feels does not include enough smaller stocks. ―Seventy-five years of history confirm that, in the aggregate, smaller stocks have tended to outperform larger ones.‖

QUARTERLY UPDATES

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6.12

Barton Malkiel’s Asset Allocation Based On Age Age

Stocks

Real Estate

Bonds

Cash

Mid-20s

65%

10%

20%

5%

Late 30s to early 40s

55%

10%

30%

5%

Mid-50s

45%

12.5%

37.5%

5%

Late 60s and older

25%

15%

50%

10%

Malkiel Index Fund Portfolio For Mid-50s Weighting

Fund (symbol)

45%

Stocks—U.S. (34%): T. Rowe Price or Fidelity Spartan; Developed (7.5%): Dreyfus or Fidelity Spartan; Emerging: (3.5%) Vanguard Emerging Market Index Fund

37.5%

Bonds—(32%) Vanguard Total Bond Market Index Fund and (5%) TIPS

12.5%

Real Estate—Vanguard REIT Index Fund

5%

Cash—Fidelity Spartan Money Market Fund

JOHN BOGLE’S PERSONAL PORTFOLIO John Bogle, age 80, has been a champion of individual investor rights for close to 60 years. His Princeton thesis dealt with offering a low-fee mutual fund. In 1999, Fortune magazine called Bogle one of the investment industry‘s four ―giants of the 20th century.‖ John has written six books. According to Bogle, ―Talk to any Nobel laureate who has ever won the economics prize and he is going to tell you to index;‖ the same is true of any college professor of finance.

The specific weighting for each fund listed below is not given by Bogle, but his largest single holding is the Vanguard Limited-Term Tax-Exempt Fund. Even though most of his portfolio is passively managed, Bogle does own some actively managed funds; his preference is value and small. Starting in 1951, John put 15% ($37.50) of his $250 monthly salary into Vanguard‘s qualified retirement plan. A number of the funds listed below have an ―Admiral Class‖ of shares wherein the expense ratio is slightly lower ($100,000 minimum in most cases).

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6.13

John Bogle’s Personal Portfolio [partial list] Weighting

Fund (symbol)

60% Bonds

[specific weightings for each fund are not given] Vanguard Inflation-Protected Securities (VIPSX) Vanguard Intermediate Term Bond Index (VBIIX) Vanguard Limited-Term Tax-Exempt (VMLTX) Vanguard Intermediate Term Tax Exempt (VWITX) Vanguard Tax-Managed Balanced (VTMFX)

40% Stocks

[specific weightings for each fund are not given] Vanguard Total Stock Market Index (VTSMX) Vanguard 500 Index (VFINX) Vanguard Extended Market Index (VEXMX) Vanguard Tax Managed Capital Appreciation (VMCAX) Vanguard Growth & Index (VQNPX) Vanguard Prime Cap Fund (VPMCX) Vanguard U.S. Growth (VWUSX) Vanguard Explorer (VEXPX) Vanguard Wellington (VWELX) Vanguard Wellesley Income (VWINX) Vanguard Windsor (VWNDX)

Excluding its life cycle (target retirement) funds, Vanguard has only one fund of funds.

The Vanguard Star Fund is comprised of 11 Vanguard funds, with approximately 60% in stocks and 40% in bonds. The Star Fund began in 1985 and is actively managed.

QUARTERLY UPDATES

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6.14

CHARLES KIRK: LONG-TERM RETIREMENT PORTFOLIO Kirk‘s retirement portfolio is 80% invested in indexed funds and 20% in individual stocks and ETFs. His approach is to sell into strength and buy when the markets are weak. Kirk is a strong advocate of buying stocks that represent future dominant trends such as clean water and clean energy such as nuclear and solar (TheKirkReport.com). His web site focuses on stock trading; Kirk is considered one of the very best active traders.

Charles Kirk’s Long-Term Passive-Aggressive Retirement Portfolio Weighting

Fund (symbol)

40%

U.S. Equities

10%

Rydex S&P Equal Weight (RSP)

10%

Vanguard Value ETF (VTV)

10%

Power Shares Zacks Micro Cap (PZI)

10%

Vanguard Small Cap Value ETF (VBR)

40%

Foreign Equities

10%

iShares MSCI EAFE Index (EFA)

10%

iShares MSCI EAFE Value Index (EFV)

10%

Vanguard Emerging Markets Stock ETF (VWO)

10%

WisdomTree International Small Cap Dividend (DLS)

10%

Sector ETFs PowerShares Water Resources (PHO) StreetTRACKS Gold Shares or other sectors (GLD)

10%

Individual Stocks 5-10 positions

QUARTERLY UPDATES

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6.15

JONATHAN CLEMENTS PORTFOLIO Clements has been a writer for The Wall Street Journal since 1994. He has written a handful of books and was a mutual fund writer for Forbes before joining the Journal. In a 2006 interview, Clements said that, ―My greatest value lies in providing readers with the reassurance that, yes, saving diligently and diversifying with index funds really is the best long run strategy.‖ All seven of the accounts he has are mostly invested in mutual funds.

Jonathan is widely considered one of the most insightful financial writers. The portfolio below can easily be duplicated by using Fidelity, Schwab, Vanguard or Barclays iShares.

Jonathan Clements’ Three-Fund Global Portfolio Weighting

Fund (symbol)

45%

T. Rowe Price Total Equity (POMIX)

40%

T. Rowe Price U.S. Bond (PBDIX)

15%

T. Rowe Price International Equity (PIEQX)

In his own portfolio, Clements has 25% in bonds but expects to increase that amount to 35-40% by retirement. For advisors who want to use more positions, Clement has an eight-asset class portfolio (see below), but he still recommends a 70-80% weighting in the three-fund portfolio above.

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6.16

Jonathan Clements’ Eight Asset Class Index Fund Portfolio Weighting

Fund (symbol)

none given

U.S. Stock Funds and/or ETFs

25-30%

Foreign Stocks Fidelity Spartan International (FSIIX) T. Rowe Price International Equity (PIEQX) Vanguard Total International Stock (VGTSX)

none given

U.S. Bonds Fidelity Inflation-Protected Bond (FINPX) Vanguard Inflation-Protected Securities (VIPSX) individual issues—TreasuryDirect.gov

5%

Gold American Century Global Gold (BGEIX)

5%

REITs Vanguard REIT Index (VGSIX)

5%

Commodities Pimco Commodity Real Return Strategy ―D‖ (PCRDX)

5%

Emerging Markets Vanguard Emerging Markets Stock Index (VEIEX)

QUARTERLY UPDATES

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6.17

PAUL MERRIMAN PORTFOLIO Merriman is considered one of the premiere mutual fund experts. He has been managing money since 1983 and wrote the 2005 book, Live It Up Without Outliving Your Money.

Paul has always advocated a balanced approach: ―The 60/40 split between equities and bonds is the way large institutional investors traditionally allocate their assets. Many young investors don‘t need any bonds; many older folks may want 70% or more in bonds.‖ Merriman has a number of model portfolios on his web site (FundAdvice.com).

The web site details the three model portfolios below and includes back-tested annualized returns and recent updates.

His preferred fund management company is Dimensional Fund Advisors (DFA). Their web site is DFAUS.com. The company has an impressive board of directors, including Rex Sinquefield, Eugene Fama and Roger Ibbotson. DFA only deals with institutional investors and a select group of financial advisors.

Paul Merriman’s Balanced Buy-and-Hold Portfolio Weighting

Fund (symbol)

6%

Schwab 1000 (SNXFX)

6%

Soundshore Fund (SSHFX)

6%

Schwab Small Cap Index (SWSMX)

6%

Heartland Value Plus (HRVIX)

6%

Cohen Steers Realty Shares (CSRSX)

6%

Schwab International Index (SWINX)

6%

Dodge and Cox International Stock (DODFX)

6%

Lazard International Small Cap Open (LZSMX)

6%

Tocqueville International Value (TIVFX)

6%

American Century Emerging Market (TWMIX)

20%

American Century Government Bond (CPTNX)

12%

American Century Short-Term Government (TWUSX)

8%

American Century Inflation-Adjusted Bond (ACITX)

QUARTERLY UPDATES

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6.18

Paul Merriman’s ETF Balanced Buy-and-Hold Portfolio Weighting

Fund (symbol)

6%

S&P 500 SPDRs (SPY)

6%

Vanguard Value ETF (VTV)

6%

iShares Russell Microcap Index (IWC)

6%

Vanguard Small Cap Value ETF (VBR)

6%

Vanguard REITs Index ETF (VNQ)

6%

iShares MSCI EAFE (EFA)

6%

iShares MSCI EAFE Value Index (EFV)

6%

WisdomTree International Small Cap Div (DLS)

6%

Vanguard Emerging Market ETF (VWO)

6%

iShares Lehman 7-10 year (IEF)

20%

iShares Lehman 1-3 year (SHY)

12%

iShares Lehman 1-3 year (TIP)

Paul Merriman’s Ultimate Buy-and-Hold Portfolio Weighting

Type of Fund

40%

Short/Intermediate Term Bonds

6%

S&P 500 Index

6%

U.S. Micro Cap

6%

U.S. Small Cap Value

6%

U.S. Large Cap Value

6%

REITs

6%

International Large Cap

6%

International Large Cap Value

6%

International Small Cap

6%

International Small Cap Value

20%

Emerging Markets

QUARTERLY UPDATES

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6.19

TIMOTHY MIDDLETON PORTFOLIO Middleton writes a weekly column for MSNMoney.com that focuses mostly on mutual funds. In the past, he was a fund columnist for the New York Times and wrote ―Abreast of the Market‖ for The Wall Street Journal Europe. Timothy has been a financial journalist for over 27 years and has been nominated for the Pulitzer Prize. For recommendations, advisors can go to MSNMoney.com and search for ―Middleton.‖ Timothy believes that, ―If you want to build a portfolio you won‘t have to touch for the next 25 years, buy sector funds that invest in financial services, health care, leisure and technology.‖

Middleton’s Four-Fund Portfolio Via Mutual Funds Weighting

Fund (symbol)

25%

Fidelity Select Financial Services (FIDSX)

25%

Fidelity Select Health Care (FSPHX)

25%

Fidelity Select Leisure (FDLSX)

25%

Fidelity Select Technology (FSPTX)

Middleton’s Four-Fund Portfolio Via ETFs Weighting

Fund (symbol)

25%

Vanguard Financial ETF (VFH)

25%

Health Care SPDR (XLV)

25%

PowerShares Leisure & Entertainment (PEJ)

25%

iShares Goldman Sachs Technology (IGM)

QUARTERLY UPDATES

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6.20

Middleton’s Monitored “Play It Safe” Portfolio Weighting

Fund (symbol)

13.5%

S&P 500 Spiders (SPY)

12.7%

PowerShares FTSE RAFI US 1000 (PRF)

9.8%

NASDAQ 100 Trust (QQQQ)

10.9%

iShares Russell 2000 (IWM)

5.9%

iShares Goldman Natural Resources (IGE)

20.1%

iShares MSCI EAFE (EFA)

9.9%

iShares Lehman Aggregate Bond (AGG)

4.9%

iShares C & S Realty (ICF)

12.2%

Schwab Investors MMF (money market)

FRANK ARMSTRONG III PORTFOLIO Armstrong‘s book, The Informed Investor: A Hype-Free Guide to Constructing a Sound Financial Portfolio (2002), is one of 11 books recommended by Business Week Online as all-time ―Must Reads for Investors.‖ Frank has created a number of life-cycle strategies ranging from 100% equities for young employees down to 40% equities for those approaching retirement. He favors small cap and value stock funds and recommends DFA for his clients.

Frank Armstrong’s Ideal Index Fund Portfolio Weighting

Fund (symbol)

31.00%

Vanguard Total International Stock (VGTSX)

30.00%

Vanguard Short-Term Bond (VBISX)

9.25%

Vanguard Small Cap Value (VISVX)

9.25%

Vanguard Value (VIVAX)

8.00%

Vanguard REIT (VGSIX)

6.25%

Vanguard Small Cap Growth (VISGX)

6.25%

Vanguard 500 Index (VFINX)

QUARTERLY UPDATES

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6.21

JIM LOWELL PORTFOLIO Lowell is the EFT columnist for Forbes magazine and a monthly columnist for Marketwatch.com. He is the publisher of the monthly newsletter, Fidelity Investor (since 1998), The Forbes ETF Advisor and The ETF Trader. Jim has also written three books, Smart Money Moves (2000), Investing from Scratch (2006) and What Every Fidelity Investor Needs to Know (2007).

Jim Lowell’s The Sower’s Growth Portfolio of Eight ETFs Category Large Cap

Fund (symbol) 40%

10%

Diamonds Trust (DIA)

15%

iShares DJ U.S. Total Market (IYY)

7.5%

Fidelity NASDAQ Composite (ONEQ)

7.5%

Power Shares Dynamic Market (PWC)

Mid Cap 15% Small Cap 10% Foreign

15% Mid Cap SPDR Trust (MDY) 10% iShares Russell 2000 (IWM) 35%

25%

iShares MSCI EAFE (EFA)

10%

iShares MSCI Emerging Markets (EEM)

QUARTERLY UPDATES

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6.22

ANDREW TOBIAS PORTFOLIO Tobias has authored a dozen books, the best-known being, The Only Investment Guide You’ll Ever Need (2005), which has sold over 1,000,000 copies. He believes that the only thing an investor needs is to dollar-cost average into a few funds. His common sense web site (AndrewTobias.com) is widely followed.

Andrew Tobias’ Simple But Far-Reaching Monthly Accumulation Portfolio Weighting

Fund (symbol)

33.3%

Vanguard Total Stock Market Index Fund (VTSMX)

33.3%

Vanguard Total International Stock Index Fund (VGTSX)

33.3%

Vanguard Inflation-Protected Securities Fund (VIPSX)

QUARTERLY UPDATES

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6.23

STANDARD & POOR’S PORTFOLIO The Outlook, a weekly newsletter published by Standard & Poor‘s, has been dispensing investment advice for over 80 years. The March 21st, 2007 issue published a portfolio of eight ETFs (see below). S&P recommends rebalancing annually.

Standard &Poor’s Model ETF Portfolio Category U.S. Stocks

Fund (symbol) 40%

34%

Large cap blend—S&P 500 SPDR (SPY)

4%

Mid cap blend—S&P 400 Mid Cap SPDR (MDY)

2%

Small cap blend—iShares S&P Small Cap 600 (IJR)

Foreign

20%

13%

iShares MSCI EAFE (EFA)

3%

iShares MSCI Japan (EWJ)

4%

iShares MSCI Emerging Mkts. (EEM)

Bonds

25%

15%

iShares Lehman Aggregate (AGG)

5%

iShares Lehman 1-3 Year Treasury (SHY)

Cash

15%

15%

U.S. Six-Month Treasury Bills

QUARTERLY UPDATES

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6.24

JOHN WASIK PORTFOLIO Wasik is a nationally known personal financial journalist and has written 10 books. John is best known for his weekly finance column for Bloomberg News that is covered by over 400 newspapers on five continents. His goal is to ―set aside 15-25% of my gross income each year. I‘m interested in beating inflation with a mostly passive diversified portfolio.

My inflation hedge is TIPS and commodities through the Pimco Commodity Real Return Strategy Fund.‖

John Wasik’s Nano Investment Plan Weighting

Fund (symbol)

20%

Vanguard Total Stock Market Index ETF (VTI)

20%

Vanguard Total International Stock Index Fund (VGTSX)

20%

Vanguard REIT ETF (VNQ)

20%

iShares Lehman TIPS Bond (TIP)

20%

iShares Lehman Aggregate Bond (AGG)

QUARTERLY UPDATES

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INDEX INVESTING

6.25

RICHARD JENKINS PORTFOLIO Jenkins is the editor-in-chief of MSNMoney.com; he joined MSN Money in 1996. In the past, Richard was a financial writer and editor for a number of California newspapers, including the Los Angeles Times. Richard‘s strategy is to invest $100 a month in one of five different ETFs, rotating among the five. He has been able to find a low-cost brokerage firm to implement this strategy and to minimize monthly costs by using Sharebuilder.com. Once the portfolio‘s total size is $25,000 or greater, Jenkins recommends using PIMCO Commodity Real Return Strategy fund (PCRDX) for the commodity portion (shown below as the Dow Jones real estate and basic materials ETFs).

Jenkins recommends annual rebalancing.

Richard Jenkins’ (MSN Money) $100 a Month Simple ETF Strategy Weighting

Fund (symbol)

33%

Vanguard Total Stock Market ETF (VTI)

25%

iShares Lehman MSCI EAFE (EFA)

17%

iShares Lehman Aggregate Bond (AGG)

17%

iShares Dow Jones U.S. Real Estate (IYR)

8%

iShares Dow Jones U.S. Basic Materials (IYM)

QUARTERLY UPDATES

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INDEX INVESTING

6.26

KIPLINGER PORTFOLIO Kiplinger has been in the financial advice business for over 82 years, publishing newsletters, magazines and books; The Kiplinger Letter dates back to 1923. Kiplinger’s Personal Finance magazine has been around for over 61 years. In a March 2005 article, a contributing editor pointed out that, ―Only 4% of stock funds beat the S&P 500 over the past decade.‖ The first portfolio below is designed to be held for at least 5-10 years.

Rebalancing is suggested when allocations ―get out of whack.‖

Kiplinger’s Five-Fund ETF Portfolio For Growth Category Large Stocks

Fund (symbol) 40% iShares S&P 500 (IVV) or iShares Russell 3000 (IVV)

Small Stocks

20% iShares Russell 2000 (IWM)

Foreign

15% iShares MSCI EAFE (EFA)

Emerging

5% iShares MSCI Emerging Markets (EEM)

Corp. Bonds

10% iShares Corporate Bond (LQD)

Cash

10% Money market fund

QUARTERLY UPDATES

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INDEX INVESTING

6.27

Kiplinger’s Five-Fund ETF Portfolio For Income Category Large Stocks

Fund (symbol) 30% iShares S&P 500 (IVV) or iShares Russell 3000 (IVV)

Small Stocks

10% iShares Russell 2000 (IWM)

Foreign

10% iShares MSCI EAFE (EFA)

Corp. Bonds

25% iShares Corporate Bond (LQD)

Short Term

25% iShares Lehman 1-3 Year Treasury (SHY)

MORNINGSTAR PORTFOLIO The managing director and editor of Morningstar is Don Phillips. Don has been with the company for over 20 years and was their first mutual fund analyst. He helped develop the company‘s style box and rating systems. One of the services the company provides are model portfolios, each designed for certain age ranges and risk levels.

Morningstar Model Portfolio For Working Years Moderate Risk Weighting

Fund (symbol)

5%

Vanguard Prime Money Market

30%

I-Bonds (TreasuryDirect.gov)

25%

iShares S&P 500 (IVV)

20%

iShares Russell Midcap Value (IWS)

10%

Vanguard Small Cap ETF (VB)

10%

Vanguard Total International Stock (VGTSX)

QUARTERLY UPDATES

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INDEX INVESTING

6.28

Morningstar Balanced Portfolio For Retirees [50% Equities] Category Large Value

Fund (symbol) 10% T. Rowe Price Value (TRVLX) Vanguard Total Stock Market ETF (VTI) or iShares Russell 1000 Value (IWD)

Large Blend

7% Vanguard Total Stock Market ETF (VTI) or iShares Russell 1000 Value (IWD)

Large Growth

10% Fidelity Blue Chip Growth (FBGRX) or T. Rowe Price Growth Stock (PRGFX)

Mid/Small Cap

10% Fairholme (FAIRX) or Royce Value (RYVFX)

Foreign

8% Dodge & Cox International Stock (DODFX) or Vanguard Total International Stock (VGTSX)

Real Estate

2.5% T. Rowe Price Real Estate (TRREX) or Vanguard REIT Index (VNQ)

Metals

2.5% No specific fund named

This balanced portfolio (equity portion shown above and bond portion shown below) is designed for the advisor looking for something that is expected to beat inflation by at least 3% a year with the expectation that there will be declines in some years and that the investor has access to other sources of retirement income, such as a pension or Social Security. The holding period for this portfolio is at least 15 years.

QUARTERLY UPDATES

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6.29

Morningstar Balanced Portfolio For Retirees [50% Fixed Income] Category Short/Med.

Fund (symbol) 20% Vanguard Short Term Bond (VBISX) or Vanguard Short Term Investment Grade (VFSTX) or Fidelity Short-Intermediate Municipal Income (FSTFX)

Inflation

15% I Bonds (for taxable accounts) or Vanguard Inflation-Protected Securities (VIPSX)

High Yield

5% Vanguard High-Yield Corporate (VWEHX) or T. Rowe Price Tax Free High-Yield (PRFHX) or Loomis Sayles Bond (LSBRX)

Foreign

5% T. Rowe Price International Bond (RPIBX)

Cash

5% No specific money market named

QUARTERLY UPDATES

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INDEX INVESTING

6.30

J.D. STEINHILBER PORTFOLIO Although he is under 40 years old, Steinhilber (AgileInvesting.com) has built up a reputation as a savvy ETF portfolio strategist. He is an ongoing contributor to SeekingAlpha.com, a site that includes input from over 200 financial writers.

Steinhilber’s Three Model ETF Portfolios Conservative Growth

Moderate Growth

Aggressive Growth

25%

30%

40%

iShares S&P 500 Index (IVV)

5%

10%

10%

iShares S&P 500 Growth (IVW)

5%

10%

10%

iShares S&P Mid Cap 400 (IJH)

0%

0%

5%

iShares Dow Jones Healthcare (IYH)

5%

5%

5%

12%

17%

20%

iShares MSCI EAFE (EFA)

7%

7%

10%

iShares MSCI Emerging Mkts. (EEM)

0%

5%

5%

Vanguard Pacific ETF (VPL)

5%

5%

5%

37%

47%

60%

30-70%

40-85%

50-95%

Money Market

22%

17%

14%

iShares Lehman 1-3 Year Treasury (SHY)

25%

20%

15%

iShares Lehman Aggregate Bond (AGG)

10%

10%

5%

FIXED INCOME

57%

47%

34%

25-70%

10-60%

5-50%

Alternative Investments

6%

6%

6%

Street Tracks Gold Trust (GLD)

3%

3%

3%

Energy Master Ltd. Ptnrs. (KYN)

3%

3%

3%

25-70%

10-60%

5-50%

Category / Fund U.S. Equity

Foreign Stocks

TOTAL EQUITY MIN. & MAX. EQUITY RANGE

MIN. & MAX. INCOME RANGE

MIN. & MAX. ALTERNATE RANGE

QUARTERLY UPDATES

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INDEX INVESTING

6.31

CARL DELFELD PORTFOLIO Carl, age 51, has been a consultant on Asian affairs to the U.S. Treasury, an international economic advisor to the U.S. Senate and a director of the Asian Development Bank in Manila. Delfeld has been an investment banker for a number of foreign banks in the Far East, taught international business courses at the University of Colorado and was even a Japanese government scholar. For the past several years he has been president of a global investment advisory firm in Colorado Springs (ChartwellAdvisor.com).

Delfeld’s Gone Fishing Portfolio Weighting

Fund (symbol)

5%

iShares Gold (IAU)

5%

iShares Pacific Ex-Japan (EPP)

10%

iShares Lehman 1-3 Year Bond (SHY)

5%

iShares Select Dividend (DVY)

10%

iShares GS Natural Resources (IGE)

10%

iShares Lehman Aggregate (AGG)

10%

iShares Europe, Asia, Far East (EFA)

5%

iShares Russell Emerging Markets (EEM)

10%

iShares S&P Global 100 (IOO)

15%

iShares TIPS Bonds (TIP)

5%

Silver ETF (SLV)

10%

Cash

QUARTERLY UPDATES

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INDEX INVESTING

6.32

DAVID JACKSON PORTFOLIO Jackson is a graduate of Oxford University and the London School of Economics. He has been involved with technology venture funding and is the founder of the web site, SeekingAlpha.com. His web site has become the largest network of stock market blogs, commentary and analysis. Over 200 financial professionals submit articles for his web site. Jackson does not include portfolio weightings for any of the five positions shown in the table below because he feels each investor‘s situation is unique.

Jackson’s Low-Maintenance Five-Fund ETF Portfolio Weighting

Fund (symbol)

not given

iShares Dow Jones U.S. Total Market Index Fund (IYY)

not given

iShares MSCI EAFE Index Fund (EFA)

not given

Vanguard Emerging Markets (VWO)

not given

streetTRACKS Wilshire REIT Index Fund (RWR)

not given

iShares Lehman Aggregate (AGG)

LARRY SWEDROE PORTFOLIO Swedroe was one of the first book authors advocating index investing. He has owned an asset management company for over a dozen years. Larry, age 57, is the author of five books, including the co-author of The Only Guide to a Winning Bond Strategy You’ll Ever Need (2006). His most popular book remains The Only Guide to a Winning Investment Strategy You’ll Ever Need (1998 and updated in 2005). For the fixed-income portion of his models, Swedroe recommends high-quality short-to-intermediate term bonds and TIPS.

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6.33

Swedroe’s Model Portfolio Allocations Conservative

Moderate

Somewhat Aggressive

Very Aggressive

Stocks

40%

60%

80%

100%

Bonds

60%

40%

20%

0%

Swedroe’s Stock Portion of Model Portfolio Weighting

Fund (symbol)

17.5%

iShares S&P 500 Index (IVV)

17.5%

iShares S&P Mid Cap 400 Value Index (IJJ)

17.5%

iShares S&P Small Cap 600 Index (IJR)

17.5%

iShares Small Cap 600 Value Index (IJS)

20%

Vanguard Tax Managed International Index (VTMGX)

10%

Vanguard Emerging Market Index (VWO)

STEVEN SCHOENFELD PORTFOLIO Schoenfeld, age 46, is the chief investment officer of quantitative global investments for Northern Trust, a portfolio of over $220 billion. Steven was also a managing director at Barclays Global Investors. He pioneered the first emerging market index fund while he was at the International Finance Corporation. Schoenfeld was a Fulbright scholar in economics at the National University of Singapore. Steven has written a number of books, including a 600+ page book titled, Index Investing (2004). He is considered one of the leaders of global indexing (www.IndexUniverse.com).

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6.34

Schoenfeld’s Model ETF Portfolio For Three Levels Of Risk Category / Fund Large Cap

Conservative Growth

Moderate Growth

Aggressive Growth

15%

30%

35%

10%

15%

20%

5%

8%

15%

0%

2%

5%

15%

5%

0%

15%

10%

5%

10%

5%

5%

10%

5%

5%

10%

5%

5%

iShares Russell 1000 (TWB) iShares S&P 500 (IVV) Mid/Small Cap iShares Russell Mid Cap (IWR) Mid Cap SPDRs (MDY) Foreign iShares MSCI EAFE (EFA) Emerging Markets iShares Emerging Markets (EEM) Fixed Income: Short-Term

iShares Lehman 1-3 Year Treasury (SHY) Fixed Income: Long-Term

iShares Lehman 20+ Year Treasury (TLT) Fixed Income: High-Yield

iShares iBoxx $ Invest. Grade Corp. (LQD) Alternatives: REITs

iShares Cohen & Steers Realty Majors (ICF) Alternatives: Commodities

iShares GSCI Commodity Trust (ICF)

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6.35

DR. MARVIN APPEL PORTFOLIO Appel, age 47 and a Harvard graduate, now specializes in computer research and mathematical modeling. Marvin is the editor of the newsletter, Systems and Forecasts.

His most recent book, Exchange Traded Funds Made Easy (2006) includes a section on asset allocation strategies. Appel recommends a 50/50 allocation mix. For the equity portion he favors REITs, the S&P 500 and small cap value because of their historically low correlation to each other. The fixed-income portion is 60% cash and 40% intermediate-term bonds (AppelAsset.com).

Dr. Appel’s Stock One-Decision Portfolio Weighting

Fund (symbol)

20%

iShares S&P 500 Index (IVV)

20%

iShares Cohen and Steers Realty Majors Index (ICF)

10%

iShares Russell 2000 Value Index Fund (IWN)

20%

iShares Lehman Aggregate Bond Fund (AGG)

30%

Cash: 90-day T-bills, bank CD or money market

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6.36

XTF PORTFOLIO XTF is a New York company that creates and markets ETFs. The company oversees about $400 million and has over 20 ETF portfolios. XTF offers 11 tactical portfolios, each one adjusts its equity exposure by 10%; for example, the ETF 70 portfolio is 70% invested in stocks and 30% in bonds. The firm also offers seven target date retirement portfolios in mostly five-year increments, from 2005 through 2040 (XTF.com).

ETF 50 Portfolio Weighting

Fund (symbol)

19%

State Street SPDR (SPY)

17%

iShares MSCI EAFE (EVA)

8%

Vanguard Mid Cap ETF (VO)

6%

iShares Russell 2000 (IWM)

10.8%

iShares Lehman 7-10 Year (IEF)

10.8%

iShares Lehman 1-3 Year (SHY)

6.9%

iShares Lehman 20 Year (TLT)

5.9%

iShares iBoxx Corporate Bond (LQD)

4.9%

iShares Lehman TIPS Bond (TIP)

9.8%

Vanguard REIT Index (VNQ)

1.0%

Cash: 90-day T-bills

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6.37

PASSIVE INVESTING SUMMARY This entire chapter has been devoted to passive investing. Most, if not all, of the twodozen sample portfolios herein should stand the test of time. There is a tremendous amount of similarity between these portfolios; certain management companies such as Barclays (iShares), Fidelity, T. Rowe Price and Vanguard are used repeatedly. Advisors who use an index approach with their clients’ money should focus on the common themes presented herein: [1] strongly consider the same management companies [2] the biggest determinant of risk and return is the equity/fixed income mix [3] seek out specialty/sector plays to round out a portfolio [4] the more asset categories used, the lower the overall volatility [5] consider the number of positions with your actual portfolio review process [6] only consider these portfolios for long-term clients [7] realize that long-term commodity returns have not been great [8] very few of these model portfolios include gold or silver [9] short and intermediate-term bonds are more favored than long-term bonds [10] small cap value and REITs should be included in most portfolios [11] there is a strong consensus among all of these portfolios [12] think outside ―this box‖ (e.g., utilities, natural resources and convertibles)

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ANNUITIES

7.2007

7.1

VARIABLE ANNUITY SALES

Sales of variable annuities for 2007 totaled just under $180 billion, a 15% increase from 2006. Total assets under management (AUM) were $1.5 trillion by year-end 2007. Over 70% of variable annuity sales went to products issued by the top 10 companies. The top 15 companies, ranked solely by new sales for 2007, were: Top 15 Sellers of Variable Annuities for 2007 [1] AXA Financial/MONY [6] Prudential/Skandia

[11] AIG Sunamerica

[2] MetLife

[7] John Hancock Life

[12] Jackson National Life

[3] TIAA-CREF

[8] ING

[13] Nationwide Life

[4] Hartford Life Insurance [9] Ameriprise Financial

[14] AEGON/Transamerica

[5] Lincoln National Life

[15] Allianz Life

[10] Pacific Life

IBBOTSON STUDY BACKGROUND A 2008 Ibbotson study shows the effect of adding a variable annuity with a living benefit to a retirement income portfolio (such as mutual funds). The study, detailed below, shows that retirement income increases and the outcome becomes more assured (lower standard deviation) when a variable annuity with a 5% annual guaranteed minimum withdrawal benefit (GMWB) is used.

The study is based on three portfolios: [1] 100% invested in an asset allocation portfolio within a variable annuity that has a GMWB feature (referred to hereafter as VA + GMWB), [2] 100% invested an asset allocation portfolio using mutual funds and [3] using a combination of the first two portfolios. In all three cases, a 5% annual withdrawal rate was assumed. The different outcomes presented below were all based on using historical market data (1979-2006) or Monto Carlo simulation. The use of a VA + GMWB means that a larger portion of the portfolio is devoted to equities (since there is a 5% annual ―floor‖) since there is no downside risk for the living benefit aspect of the variable annuity. Whenever used, the VA + GMWB portion has a weighting of 80% in stocks and 20% in bonds. The study looks at two different periods of time: [1] 28 years of historical data (1979-2006) and [2] projected returns for the next 30 years, using Monte Carlo simulation.

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7.2

As you may recall from previous readings, a variable annuity with a living benefit rider has two values: contract value (subject to the ups and downs of the markets) and a living benefit value (a guarantee of 5-7% per year that is credited by using either simple or compound interest). A number of living benefit riders, including the GMWB used in this example, also include a ―highest anniversary‖ lock in that can be used if an anniversary value ends up being greater than the 5-7% guaranteed growth rate.

In this Ibbotson study, the living benefit used is a guarantee that the investor will receive at least 5% of the annuity contract‘s initial value each year in the form of an annual distribution at the beginning of the year (what is referred to as a guaranteed minimum withdrawal benefit or GMWB). When the initial investment has net growth (after the annual distribution), the investor is able to annually lock-in this higher value (and begin taking 5% of a larger amount) at each anniversary date (which is simply the date the investment began). Contract value adjustments for living benefit purposes can only ratchet upward, never downward. An example of how this type of living benefit works is given below.

Ibbotson performed the study, which was funded by Nationwide Financial, an insurance company that offers variable annuities (VAs) and living benefit riders such as GMWB. This 2008 report continues earlier work done by Ibbotson, showing the impact of including insurance products into an investment portfolio (e.g., Chen and Milevsky, 2003; Chen, Ibbotson, Milevsky and Zhu, 2006 and 2007). All return figures and comparisons sited in this study are based on the following assumed fee structure: Portfolio Fee Structure Mutual Funds vs. Variable Annuities (with living benefit) Type of Fee

Mutual Fund

VA + GMWB

Fund/Subaccount Management Fee

1.0%

1.0%

Advisor (Wrap) Fee *

1.0%

1.0%

VA M&E Fee

n/a

0.4%*

GMWB Rider Fee

n/a

0.6%

2.0%

3.0%

Total Fees

* It is assumed that the advisor/broker receives a 1% annual fee, either in the form of a wrap fee or a trailing commission by the variable annuity—this is why the 1.4% M&E fee for the variable annuity is divided into two parts.

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7.3

OVERVIEW OF STUDY’S CONCLUSIONS As one would suspect, as the equity portion of a mutual fund portfolio increases, income also increases, but so does the volatility of the income stream, what Ibbotson refers to as higher ―semi-deviation‖ and defines as ―the standard deviation of negative income changes over the last period.‖ The portion of the portfolio that uses a VA + GMWB has no income risk (because of the 5% annual guarantee). As mentioned above, whenever the VA + GMWB is added, the equity portion of the portfolio increases and the fixed-income portion decreases.

Over the 28-year period 1979-2006 and over the next 30 years in the future (simulated), whenever a VA + GWMB was added to a conservative, conservative-tomoderate or moderate portfolio, the average sustainable income level increased; the chances of an “income shortfall” from year to year also decreased (note: since all portfolios were designed for retirement income, no aggressive portfolios were included).

Within the study, the ―income return‖ is ―defined as the income change in percentages in two consecutive years.‖ The ―shortfall income risk‖ is defined as ―the risk of running out of income when the market has performed poorly for an extended period of time.‖

QUICK REVIEW OF GMWB RIDER The guaranteed minimum withdrawal benefit (GMWB) is one type of living benefit that can be added to a number of variable annuities. The annual cost for this rider averages about 0.60% and typically lasts for the life of the annuity contract. The GMWB allows the investor to withdraw 5-7% of the ―benefit base‖ each year until death. The ―benefit base‖ (sometimes referred to as the ―living benefit value‖) can never decrease below the investor‘s original principal. However, if there is an increase in the contract‘s value due to the performance of the underlying subaccount(s), the benefit base can ratchet upwards.

An upward ratcheting results in two things: [1] an increase in the annual income received by the investor and [2] a new benefit base that can never be adjusted downward.

For example, your client invests $100,000 in a VA + GMWB; the GMWB guarantees a minimum annual withdrawal rate of 5%. This means the client is entitled to $5,000 a year, even if the contract‘s value drops to $90,000, $20,000 or any other figure. However, if the contract ends up growing to, say $130,000 on an anniversary date, the $130,000 becomes the new benefit base. The client can then start taking out $6,500 a year (5% of $130,000), an amount that can never go down in future years, but could go up if the anniversary value ever surpassed $130,000.

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7.4

Although the ―benefit base‖ of a VA + GMWB can certainly increase, keep in mind the ―hurdles‖ that need to be crossed: 5% withdrawal plus 3% in fees. In short, the overall return of the subaccounts used by the VA need to average more than 8% a year in order for there to be any benefit base growth. Moreover, if the contract‘s value drops by a fair amount over the course of a few years, the chances of any benefit base are highly unlikely. For example, if the subaccounts had flat returns (meaning they averaged 3% a year to offset all of the VA fees), a $100,000 investment be worth $78,350 after five years of $5,000 annual withdrawals. The chances that $78,350 will ever grow to more than $100,000 when there is an annual debit of $5,000 plus 3% in fees is possible but unlikely (although the real world example below shows such increases).

On a positive note, if the benefit base increases in the early years, the resulting ―lock in‖ can result in a windfall for the investor—a windfall that would be difficult, if not impossible, to match with any other kind of portfolio (since we are talking about locking in a higher return that can never decrease vs. a non-annuity portfolio whose income stream will fluctuate the greater the equity exposure).

The first table below shows a moderately aggressive asset allocation portfolio (80% equities and 20% in bonds) used by the variable annuity (note: even retirees should be at least somewhat aggressive with the living benefit portion of their portfolio—bonds become almost a moot consideration since the VA has a 5-7% annual floor). Most VAs do not allow 100% to be invested in equities if a living benefit such as a GMWB is used (less in equities means lower risk to the insurer). It is important to keep in mind that whenever a VA + GMWB is used, the portfolio of the VA is what is shown below. The second table shows annual returns starting in 1979, net of all VA fees (note: GMWBs did not exist until the mid-to-late 1990s).

VA + GMWB Portfolio Portfolio Weighting

Asset Class

Benchmark Index

U.S. Large-Cap Stocks

Russell 1000

35%

U.S. Mid-Cap Stocks

Russell MidCap

15%

U.S. Small Stocks

Russell 2000

5%

Foreign Stocks

MSCI EAFE

25%

U.S. Bonds

Lehman Aggregate Bond

15%

Short-Term Bonds

Lehman 1-5 Yr. Gov‘t

5%

Total

100%

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7.5

As you can see from the table below, a variable annuity invested in moderately aggressive portfolio (80% stocks and 20% bonds) fared quite well, despite a 3% annual fee drag on performance. The broker of record also fared well, taking in a 1% annual trailing commission (advisory fee) that started out at $10,000 the first year (1% of $1 million) and grew to an annual fee of $26,500 by the end of 2006 (1% of $2,652,000).

The insurance company also did well when it comes to fees: taking in $6,000 in GMWB rider fees the first year and experiencing a steady increase each subsequent year, with a cumulative total of $444,300 by the end of 2006 (shown in boldface below).

The investor also fared well. From a beginning value of $1,000,000, the account grew to $2,652,000 by the end of 2006 along with a living benefit that was worth $3,832,000 for withdrawal benefit purposes (5% of $3,832,000 = $191,600 in yearly benefits (from 1999 through 2006) that can only stay the same or increase each year in the future. Remember, the investor‘s level of annual income can only ratchet upward, never downward (the benefit of a guaranteed withdrawal benefit). The contract value certainly declined about 36% of the time (1981, 1984, 1987, 1990, 1992, 1994, 2000, 2001, 2002 and 2005), but not the benefit base, which either stayed flat or increased each year.

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7.6

Variable Annuity With 5% Guaranteed Withdrawal Benefit (GMWB) 1979-2006 [portfolio = 80% equities and 20% bonds] VA+GMWB Net Return

Contract Value $1,000,000

Benefit Base $1,000,000

Guaranteed Annual Income $50k

Rider Fee $6k

1979

14.6%

$1,082,000

$1,082,000

$54k

$6.5k

1980

22.5%

$1,251,000

$1,251,000

$62.6k

$7.5k

1981

$1,152,000

$1251,000

$62.6k

$7.5k

1982

-2.5% 15.3%

$1,247,000

$1,251,000

$62.6k

$7.5k

1983

18.2%

$1,392,000

$1,392,000

$69.6k

$8.4k

1984

4.1%

$1,367,000

$1,392,000

$69.6k

$8.4k

1985

33.5%

$1,722,000

$1,722,000

$86.1k

$10.3k

1986

27.2%

$2,068,000

$2,068,000

$103.4k

$12.4k

1987

5.1%

$2,052,000

$2,068,000

$103.4k

$12.4k

1988

16.5%

$2,255,000

$2,255,000

$112.8k

$13.6k

1989

18.5%

$2,522,000

$2,522,000

$126.1k

$15.1k

1990

-10.5%

$2,130,000

$2,522,000

$126.1k

$15.1k

1991

23.9%

$2,464,000

$2,522,000

$126.1k

$15.1k

1992

2.6%

$2,383,000

$2,522,000

$126.1k

$15.1k

1993

14.3%

$2,563,000

$2,563,000

$128.1k

$15.4k

1994

-1.1%

$2,392,000

$2,782,000

$128.1k

$15.4k

1995

23.7%

$2,782,000

$2,782,000

$139.1k

$16.7k

1996

11.5%

$2,928,000

$2,928,000

$146.4k

$17.6k

1997

16.9%

$3,231,000

$3,231,000

$161.5k

$19.4k

1998

15.2%

$3,514,000

$3,514,000

$175.7k

$21.1k

1999

15.5%

$3,832,000

$3,832,000

$191.6k

$23.0k

2000

-5.4%

$3,424,000

$3,832,000

$191.6k

$23.0k

2001

-11.1%

$2,854,000

$3,832,000

$191.6k

$23.0k

2002

-15.4%

$2,233,000

$3,832,000

$191.6k

$23.0k

2003

27.0%

$2,564,000

$3,832,000

$191.6k

$23.0k

2004

11.5%

$2,619,000

$3,832,000

$191.6k

$23.0k

2005

5.9%

$2,545,000

$3,832,000

$191.6k

$23.0k

2006

13.8%

$2,652,000

$3,832,000

$191.6k

$23.0k

Total

$3.7 million

$444.3k

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7.7

Monte Carlo Simulation A total of 5,000 simulations were used for the portion of the Ibbotson study that projected returns for the next 30 years. For each year, a random return number was generated for each of the seven asset classes used; an overall return for the portfolio was then calculated. All simulations assume that the retirement income is taken out at the beginning of each year and that all figures are net of expenses (3% per year in the case of the variable annuity and 2% for mutual funds—the fund fees are higher than one might suspect because it is assumed the broker is receiving a 1% yearly account wrap fee). A substantial portion of the study is based on projected future returns of stocks and bonds for the next 30 years (based on Ibbotson assumptions which assume lower returns than what was actually experienced from 1979 through 2006).

In the case of the simulated results for the next 30 years in the future, the Monte Carlo ―runs‖ ($1 million invested, 80% in equities and 20% in bonds for the VA + GMWB portion, future returns expected to be less than what they were in the past, different return figures used for each simulation and income starting out at $50,000 per year), there was a 50% chance that a 65-year-old‘s annual return would rise modestly, but steadily and result in an annul income stream of $72,770 when the investor reached age 95 (at the end of 30 years); there was only a 10% chance that the income stream would stay at $50,000 each year (which assumes a flat or negative market for the 30 years), a 75% chance that the annual income stream would rise to $110,546 by the 30th year and a 90% likelihood that the ending annual income would be $172,573. Keep in mind that none of the simulations ever assumed an annual income stream of less than $50,000 because of the GMWB feature.

Income Return Deviations For this part of the study, Ibbotson looked at three ―model portfolios‖ (conservative, moderate conservative and moderate). In each case, a portion of the fixed income/cash portion of the portfolio was replaced with a more aggressively allocated VA + GMWB (specifically, the VA was 80% in equities and 20% in bonds–what is described as ―moderately aggressive‖). The three model portfolios along with a moderately aggressive portfolio (the result of replacing bonds with a stock/bond VA) are shown in the table below. For example, the ―Moderate Conservative‖ portfolio has an asset allocation of 40/60 (stocks/fixed income); if 15% of the fixed income portion is replaced with 15% VA + GMWB, the ―new‖ portfolio will have 47% in stocks and 53% in fixed income.

Phrased another way, the replaced portfolio will have an allocation of 40/45/15 (stocks/fixed income/VA + GMWB).

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7.8

As one would suspect, replacing part of the fixed income with a VA + GMWB increases risk and return (since the GMWB guarantees an income stream, not the value of the underlying assets). However, the combined portfolios (meaning those portfolios wherein some of the fixed income was replaced with an 80/20 VA) all have lower income risk and higher total income returns than the ―Moderate Conservative‖ portfolio.

Again, Monte Carlo simulation was used to discern what would happen over various types of markets for the next 30 years. The 5,000 simulations showed different rates of return, different standard deviations and different covariances. Based on the simulated outcomes, Ibbotson was able to determine the impact of different asset allocations and the probability of reaching retirement goals—over a broad spectrum of risk and return scenarios.

As you will see from the table below, the ―Conservative‖ portfolio is 20% invested in stocks and 80% in fixed income. The ―Moderate Conservative‖ portfolio has 40% in stocks. The ―Moderate‖ portfolio has 60% in stocks and ―Moderate Aggressive‖ has 80% in stocks and 20% in fixed income. The next table below shows the results of such portfolios based on historical returns from 1979 through 2006. The table also shows Ibbotson projections for the next 30 years for annualized returns and standard deviation (the far-right two columns).

Historical and Projected Returns and Standard Deviations 1979-2006 Annualized

1979-2006 Std. Dev.

Ibbotson Projected Returns

Ibbotson Projected Std. Dev.

Large Cap

13.5%

15.6%

11.0%

19.5%

Mid Cap

15.3%

15.1%

12.6%

22.3%

Small Cap

13.3%

18.5%

14.7%

28.7%

Foreign

11.9%

21.7%

11.4%

24.6%

Bonds

8.8%

7.5%

5.2%

7.0%

S.T. Bonds

8.1%

5.0%

4.1%

4.2%

Cash

6.2%

3.3%

3.5%

3.0%

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7.9

Asset Allocation Portfolios Index

Conservative

Moderate Conservative

Moderate

Moderately Aggressive

Large Stocks

Russell 1000

10%

20%

30%

35%

Mid Cap Stocks

Russell MidCap

5%

10%

10%

15%

Small Cap

Russell 2000

0%

0%

5%

5%

Foreign Stocks

MSCI EAFE

5%

10%

15%

25%

U.S. Aggregate Bonds

LB Aggregate Bond

40%

35%

25%

15%

Short-Term Bonds

LB 1-5 Government

25%

15%

10%

5%

Cash

3-Mo. T-bill

15%

10%

5%

0%

Asset

   

Conservative = 80% in bonds and 20% in stocks Moderate Conservative = 60% in bonds and 40% in stocks Moderate = 40% in bonds and 60% in stocks Moderately Aggressive = 20% in bonds and 80% in stocks (the VA + GMWB)

Ibbotson then ran a comparison as to what would have happened if part of the fixed income portion of the ―Moderate Conservative‖ portfolio (40% stocks/60% bonds) were partially replaced with a VA + GMWB (40% stocks/45% bonds/15% VA + GMWB). As you may recall, the VA + GMWB has an 80% weighting in stocks and 20% weighting in bonds. It was also assumed that $1 million was invested at the beginning of 1979 and held through 2006 and that the 5% was taken out of each of the two portfolios.

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7.10

$1 Million Moderate Conservative Portfolio (40% stocks/60% bonds) Invested For Income [1979-2006] 40/60 $1 million

40/60 Income $50,000 ($50k)

40/45/15 $1 million

40/45/15 Income $50,000 ($50k)

1979

$1.03 mil

$51.8k

$1.06 mil

$52.8k

1980

$1.12 mil

$55.8k

$1.17 mil

$58.5k

1985

$1.61 mil

$80.7k

$1.66 mil

$83.1k

1990

$1.93 mil

$96.5k

$2.01 mil

$103.7k

1995

$2.35 mil

$117.6k

$2.52 mil

$125.9k

2000

$2.68 mil

$133.8k

$2.97 mil

$151.5k

2005

$2.41 mil

$120.6k

$2.57 mil

$138.3k

2006

$2.47 mil

$123.7k

$2.66 mil

$142.1

total

$2.89 million

$3.15 million

As you can see, by replacing 15% of fixed income with a VA + GMWB (shown above as 40/45/15), annual income increases, cumulative distributions increase (from $2.89 to $3.15 million and so does ending principal (from $2.47 to $2.66 million). What is not shown in the table above is the fluctuation of annual income distributions (since not every year is provided). Annual income is going to fluctuate for two reasons: [1] 5% of the account value for each portfolio is taken out each year and returns vary from year to year and [2] the 5% guarantee for the second portfolio (40/45/15) only applies to 15% of its total.

For the ―Moderate Conservative‖ portfolio (40% stocks/60% bonds), income declined in the following years (by the amount shown in parentheses): 1981 (-2.6%), 1987 (-1.8%), 1990 (-5.9%), 1992 (-1.0%), 1994 (-6.9%), 2000 (-3.2%), 2001 (-7.3%), 2002 (-9.3%) and 2005 (-1.9%). For example, the investor received $138,242 at the beginning of 1999 but just $112,443 at the beginning of 2002. For the ―Moderate Conservative‖ portfolio with VA + GMWB (40/45/15), income declined in the following years: 1981 (-2.4%), 1987 (-1.1%), 1990 (-6.0%), 1992 (-1.0%), 1994 (-5.4%), 2000 (-3.7%), 2001 (-7.2%), 2002 (-9.1%) and 2005 (-1.1%). This means that in most instances of declining income, a slightly greater reduction was experienced by the portfolio without the VA + GMWB. It also means that both portfolios suffered declining income for the exact same calendar years.

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7.11

The ―Moderate Conservative‖ portfolio with VA + GMWB also experienced greater increases. For example, the four greatest percentage increases in annual income were (percentage increase shown in parentheses): 1985 (+18.0%), 1982 (+14.4%), 1995 (+13.2%) and 1980 (10.7%). Without VA + GMWB, the four biggest increases were: 1985 (+19.4%), 1986 (+14.1%), 1995 (+12.7%) and 1989 (9.7%).

The next table summarizes what would have happened for the period 1979 through 2006 if three conservative portfolios were used for income: 20% stocks/80% bonds, 20% stocks/60% bonds/20% VA + GMWB and 20% stocks/40% bonds/40% VA + GMWB. In each case, 5% was taken out at the beginning of each year (shown cumulatively under the column ―Total Withdrawn‖ below).

Three Income-Producing Portfolios [1979-2006] Total Withdrawn

Ending Value

20/80

$2.39 million

$1.69 million

20/60/20

$2.71 million

$1.89 million

20/40/40

$3.03 million

$2.09 million

Portfolio

Unlike the previous table, the table below is based on Monte Carlo simulation— projecting returns for the next 30 years, based on 5,000 simulations using different rates of return and risk levels for each year. As you can see, the greater the weighting in the VA + GMIB, the greater the likelihood of increased returns. For example, the first portfolio shown below (80/20) has a 90% likelihood of the investor taking out $1.51 million and still ending up with $955,900 at the end of 30 years. Compare this to a portfolio that includes 20% in a VA + GMWB (60/20/20), which has a 90% likelihood of paying out $1.90 million and having an ending value of $1,276,000. When the VA + GMWB percentage is increased to 40% (40/20/40), the simulation shows that there is a 90% likelihood that the investor will take out a total of $2.33 million and still have an ending value of $1,648,000.

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7.12

Monte Carlo Simulations for Conservative $1 Million Portfolios [30 years of projected returns]

80% bonds/20% stocks

60% bonds/20%stocks/20%VA

40% bonds/20%stocks/40%VA

Likelihood 90%

Total Withdrawn $1.51 million

Ending Value $955,900

75%

$1.35 million

$781,000

50%

$1.20 million

$630,000

25%

$1.08 million

$505,000

10%

$0.97 million

$424,000

90%

$1.90 million

$1,276,000

75%

$1.61 million

$872,000

50%

$1.36 million

$582,000

25%

$1.20 million

$433,000

10%

$1.10 million

$352,000

90%

$2.33 million

$1,648,000

75%

$1.88 million

$998,000

50%

$1.52 million

$505,000

25%

$1.31 million

$339,000

10%

$1.20 million

$269,000

The next table is formatted the same as the one above, but is based on Monte Carlo simulation for a ―Moderate Conservative‖ portfolio (60% in bonds and 40% in stocks).

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7.13

Monte Carlo Simulations for Moderate Conservative $1 Million Portfolios [30 years of projected returns]

60% bonds/40% stocks

45% bonds/40%stocks/15%VA

25% bonds/40%stocks/35%VA

Likelihood 90%

Total Withdrawn $2.00 million

Ending Value $1,628,000

75%

$1.69 million

$1,216,000

50%

$1.42 million

$894,000

25%

$1.20 million

$652,000

10%

$1.04 million

$502,000

90%

$2.34 million

$1,943,000

75%

$1.91 million

$1,322,000

50%

$1.54 million

$866,000

25%

$1.28 million

$590,000

10%

$1.12 million

$437,000

90%

$2.86 million

$2,461,000

75%

$2.22 million

$1,487,000

50%

$1.71 million

$823,000

25%

$1.39 million

$493,000

10%

$1.22 million

$343,000

The next table summarizes what would have happened for the period 1979 through 2006 if three moderate portfolios were used for income: 60% stocks/40% bonds, 60% stocks/30% bonds/10% VA + GMWB and 60% stocks/15% bonds/25% VA + GMWB. In each case, 5% was taken out at the beginning of each year (shown cumulatively under the column ―Total Withdrawn‖ below).

Moderate Portfolios [1979-2006] Total Withdrawn

Ending Value

60/40

$3.44 million

$3.10 million

60/30/10

$3.63 million

$3.24 million

60/15/25

$3.91 million

$3.46 million

Portfolio

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7.14

Again, the greater the weighting in the VA + GMWB, the more the client would have ended up with for the period 1979 through 2006. The next table is formatted the same as two of the previous tables, but is based on Monte Carlo simulation for a ―Moderate‖ portfolio (40% in bonds and 60% in stocks).

Monte Carlo Simulations for Moderate $1 Million Portfolios [30 years of projected returns]

40% bonds/60% stocks

30% bonds/60%stocks/10%VA

15% bonds/40%stocks/25%VA

Likelihood 90%

Total Withdrawn $2.74 million

Ending Value $2,788,000

75%

$2.15 million

$1,877,000

50%

$1.67 million

$1,232,000

25%

$1.31 million

$806,000

10%

$1.08 million

$561,000

90%

$3.03 million

$3,127,000

75%

$2.32 million

$1,984,000

50%

$1.76 million

$1,227,000

25%

$1.37 million

$760,000

10%

$1.13 million

$513,000

90%

$3.54 million

$3,780,000

75%

$2.60 million

$2,202,000

50%

$1.90 million

$1,222,000

25%

$1.45 million

$686,000

10%

$1.19 million

$426,000

CONCLUSIONS The Ibbotson study looked at income returns for different simulated and historical return portfolios. The study looked at: [1] a 100% investment in the VA + GMWB (which has an 80% weighting in equities and 20% in bonds), [2] different mutual fund portfolios (whose stock weighting ranged from 20% to 60%) and [3] a combined portfolio of mutual funds plus different VA + GMWB weightings. Whenever the VA + GMWB was introduced, stock weighting increased while the bond portion of the mutual fund holdings decreased.

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7.15

The combined portfolios (mutual funds plus VA + GMWB), despite their slightly higher risk profile, had lower income risk and higher total income returns than the corresponding portfolios that did not include a VA + GMWB (because of the 5% guaranteed annual income stream from the GMWB feature). The tradeoff, or potential downside risk, of increasing stock exposure by using a VA + GMWB is that the client‘s principal will most likely end up being lower in a combined portfolio when the stock market performs worse than average for extended periods of time. Obviously, if stocks do about as well as their historical average, ending principal will be higher with a combined portfolio.

The Monte Carlo simulation used looked ahead for the next 30 years to estimate what a sustainable annual income would be using different model portfolios. The projected returns were lower than what the markets experienced from 1979 through 2006. The simulation, which incorporated 5,000 different ―computer runs,‖ also looked at the odds of an income shortfall—not obtaining $50,000 or more of annual income. In all cases, the addition of a VA + GMWB to part of the portfolio enhanced income while reducing any shortfall income risk. Obviously, the probability of a 65-year old client living an additional 30 years increases when looking at a married couple.

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