APPROPRIATE BALANCE FINANCIAL SERVICES, INC.
500 108th Ave NE, Suite 910
Bellevue, WA 98004
ph: (425) 451-0499
www.appropriatebalance.com
[email protected]
Written and Edited By:
Bruce Yates, CFM
Robert Pennell
Margaret Youch
Reginald Tilley, III, CFP®
Edwin Woo
Mary Ann Ferreira, CFP ®
Richard Merrifield, CFP ®
On Balance is published quarterly by
Appropriate Balance Financial Services,
Inc. (ABFS), a Washington corporation,
which is registered with the U.S. Securities
and Exchange Commission as a Registered
Investment Advisor. Information herein is
from sources believed to be reliable, but
whose accuracy we do not guarantee.
Subscriptions are free to clients of ABFS
and others at the sole discretion of ABFS.
Reproduction without express permission
of ABFS is prohibited. On Balance is not
reviewed, endorsed, or approved by any
regulatory agency. Employees of ABFS
may buy and sell the same securities
owned by or purchased for clients, but
manipulative trading or placing employee
orders ahead of client orders is strictly
prohibited. Certain employees of ABFS
(Bruce Yates, Marhe Youch, Mary Ann
Ferreira, Phil Platt and Kristy Carpenter)
are concurrently registered representatives
of Pacific West Securities, Inc., a registered broker/dealer. The latest version of
our disclosure document, SEC Form ADVPart II, is available at any time upon
request.
Volume 13 Issue 1 | January 22, 2008
Market Recap & Outlook
Fed Struggles with Stagflation,
Recession Fears, Bear Market
take advantage of the opportunities they create.
Ladies and gentlemen, please fasten your
seat belts. If the first few weeks of 2008 are
any indication, this year could be a wild
ride. As you will see in the pages ahead, it is
already proving to be a year when you can
be glad ABFS is managing your investments. We may not be able to avoid every
rut and pothole in the road, but we think we
can keep your long-term plans moving
ahead...and keep you from skidding into the
ditch.
Three types of news seem unavoidable
these days: political wrangling, worrisome
economic data, and depressing stock market
reports. We won’t venture into speculation
about the election (at this point, the presidential nomination of both parties is really
still up for grabs). We have our hands full
just trying to sort out what’s happening with
the economy and investment markets.
From an overview standpoint, it is important to realize that, despite significant economic problems, at its core the current
situation is part of the normal cyclical pattern of the economy and financial markets.
We have been saying for awhile now that
the economy was due for a recession, and
that a bear market for stocks was long overdue. As bad as the daily news makes it
sound, none of this should be that surprising.
Capitalism breeds extremes, and as surely as
excesses arise, they are followed by periods
of retrenchment to correct the excess.
That is not to say we shouldn’t pay attention to what is happening. Part of our job
here at ABFS is to take investment action to
help you weather these cycles—and try to
The Economy
The term “stagflation,” which is used to describe periods of stagnant economic growth
combined with surging inflation, is popping up
more and more these days. Both components
seem to be getting worse, with no end in sight.
The economic slowdown, triggered by a
bursting of real estate and credit bubbles, seems
far from over. The question seems less and less
to be whether the U.S. will enter a recession,
(See Recap & Outlook on page 2)
2008 Educational Workshop Series
Join us February 12th from 4-6PM for our
first 2008 client workshop, Globalization:
Investments, Risks & Opportunities. ABFS
senior portfolio managers Bruce Yates and
Bob Pennell will be joined by the ABFS team
of advisors to host a discussion including:
x The outlook for U.S./global economies and
stock markets, with implications for ABFS
investment strategies
x How to profit from the weak U.S. dollar
x China, India and the Middle East’s charge
into capitalism
x Skyrocketing demand for natural resources
x Sovereign Wealth Funds: What they are
and why they’re changing investing
We will record this presentation, so if you
are unable to attend in person (for example,
because you live outside the area), just let us
know; we’ll send you a DVD at no charge.
Anyone receiving On Balance is welcome
to attend, and you are welcome to bring
guests. But please RSVP (to Alicia at 425451-0499 or [email protected])
because space is limited.
The workshop will be in our office building here in Bellevue. Admission, parking and
refreshments are complimentary. Ƈ
(Recap & Outlook—continued from pg 1)
but how severe and prolonged that recession will be.
Many economists believe the economy is already growing at 1.5% or less.
Former Fed chairman Alan Greenspan
recently said the odds of recession are
“clearly rising,” and Goldman Sachs
forecasted “2-3 quarters” of “mild” recession. David Rosenberg, North American Economist for Merrill Lynch, says
that the U.S. economy is already in recession.
Indeed, signs of recession—tumbling
housing markets, sluggish consumer
spending, and job losses in manufacturing and retailing—are widespread. Not
all areas of the U.S. are affected equally,
however, and it is possible that the overall U.S. economy will avoid “official”
recession (defined as two consecutive
quarters of negative growth). Certain
parts of the country—areas that experienced the most dramatic real estate bubbles, such as sections of Florida, Colorado, California, Arizona and Nevada—
are undoubtedly already in the midst of
regional recessions.
Inflationary Forces
Economic data also reveal increasing
inflationary pressures. Normally, inflation is subdued by a slowing economy
because economic weakness relieves
pressure on wages and prices. But the
consumer price index was up at an annual rate of 4.3% for the 12 months ending in November despite increasing evidence of recession.
Two things seem to be keeping the
weakening economy from holding inflation in check this time. First, global demand for commodities—spurred by the
unprecedented infrastructure and manufacturing build-up in China, India and
other “developing” nations—is keeping
pressure on the prices of raw materials,
from oil and timber to copper and steel.
Second, the declining U.S. dollar is inherently inflationary because it raises the
prices of imports.
Oil and food prices remain stubbornly high. Soybeans reached a 34-year
high ($12.48 per bushel) in late December. Oil recently topped $100 per barrel
for the first time, nearly double its
price of $52.99 in January of last year.
Alarming price increases are also
continuing in traditional harbingers of
inflation. Gold surpassed $900 an
ounce for the first time this month,
and silver rose above $16 an ounce.
Like oil, rising gold and silver prices
in part reflect the falling U.S. dollar,
but they are also menacing because
they often reflect people’s perception
of future inflation.
Bond Yields
As a rule, rising inflation expectations cause interest rates to rise as
well. Recently, however, Treasury
yields across the board (short-term to
More than 2/3 of the 1500
stocks in the broad S&P 1500
index are now in bear market
territory (down more than 20%
from their 52-week highs).
long-term) have been falling. This is
partly attributable to a “flight to quality,” as investors selling stocks and
low-quality bonds have rushed into
Treasury securities as a safe haven.
When prices are bid up, yields fall.
Another interpretation of falling
interest rates is more worrisome. By
aggressively pushing interest rates
lower, the bond market is in essence
predicting a recession, and indicating
that the Fed will be forced to continue
cutting rates to avoid or minimize the
depth of that recession.
2
A Rock and a Hard Place
All of this has put the Federal Reserve
(Fed) in a difficult position. December
ended with news of the weakest new
home sales since 1995, but also with the
dollar down again against major global
currencies. On one hand, lowering interest rates (to stimulate the economy and
reduce the recessionary impact of the
housing slump) could drive the dollar
even lower; global investors are attracted
to currencies with higher yields. On the
other hand, raising rates (to subdue inflation and bolster the dollar) risks sending
the U.S. economy into a tailspin.
It looks like the Fed has decided to err
on the side of preventing recession,
rather than stemming inflation or the
falling dollar, at least in the short run.
Following a weekend of panic selling in
foreign stock markets, the Fed today cut
the federal funds rate by 3/4% (to 3.5%
from 4.25%), the biggest cut in more
than 23 years.
This appears to confirm Fed Chairman
Ben Bernanke’s pledge a few weeks ago
that the Fed stands “ready to take substantive additional action as needed to
support growth and to provide adequate
insurance against downside risks.” Today’s dramatic cut was undoubtedly designed to shore up deteriorating consumer and investor confidence, but it also
reflects acknowledgement by the Fed that
the U.S. economy is in trouble. Many
economists believe that today’s cut won’t
be nearly enough, and that the Fed will
cut rates by another half percent (to
3.25%) at its regular meeting next
week...and more in the months to come.
Stocks Not Coping Well
Stock investors finally seem to have
taken off their rose-colored glasses and
have started focusing on the dark economic clouds on the horizon. They have
expressed their anxiety by selling. After a
strong third quarter, the S&P 500 index
lost 3.8% in the fourth quarter, finishing
2007 up only 3.5% for the year.
2008 has started off even worse. Frustration over disparate and seemingly conflicting economic and inflation data led
stocks to suffer their worst first five trad-
ing days in history. The S&P 500
plunged a whopping 5.3% over those
five days (the previous record of -5.2%
occurred in 1932). The first five days of
the year are considered significant because a strong start over those five days
has been followed by a strong year for
the market 86% of the time, according
to the Stock Trader’s Almanac.
Selling has continued since that first
week. Every major U.S. stock index is
now suffering double-digit losses—
more than erasing all of their 2007
gains. Through today (January 22nd),
the Dow Jones Industrial Average is
down almost 1,300 points since the start
of the year. The S&P 500 is down
10.75% year-to-date (YTD), and—like
the Dow—is more than 15% below its
2007 high point. The small-company
Russell 2000 has suffered the worst,
The bulk of a market decline generally occurs in the months leading
up to the actual start of a recession.
In other words, by the time we officially know we’re in recession,
the bulk of the bear market may be
behind us.
and is now down more than 20% from
last year’s high.
Aside from the Russell 2000, most
U.S. stock indexes are not yet down
20%, which is the amount that defines a
bear market. However, the flood of individual stocks already suffering bearmarket-size losses is leading more and
more analysts to conclude that the long
wait for a bear market is in fact over.
Damage to individual stocks is
worse than the indexes suggest. More
than 2/3 of the 1500 stocks in the broad
S&P 1500 index are now in bear market
territory (down 20% or more from their
52-week highs). Little wonder that
James Stack, editor of InvesTech Research, says, “It’s already a bear market.”
This is a classic case of a bear market “sneaking up” on people. Bear markets don’t announce their arrival; you
just suddenly find that you’re in one. As
Robert Maltbie of Millennium Asset
Management notes, bear markets just
“start taking (stocks) out one by one.”
Is the Worst Over?
If we officially go into recession
(which odds increasingly favor), history suggests that stocks have considerably further to fall. A Citigroup
study of the past nine recessions
shows that the S&P 500 index declines an average of 25.6% from its
high point. As you can see from the
“Bear Watch” table above, that suggests there may still be a ways to go.
As discussed below, investors have
been selling before a recession is certain. Investors pulled $16.3 billion out
of U.S. equity mutual funds and ETFs
in the first nine trading days of 2008.
That is more than all of the monthly
withdrawals for the last two years.
This is normal; investors historically tend to sell in advance of bad
news. In fact, the Citigroup study
found that the bulk of a market decline
generally occurs in the months leading up
to the actual start of a recession. In other
words, by the time we officially know
we’re in recession, the bulk of the bear
market may be behind us.
Based on the above, you might conclude that the best thing to do is pull all
of your money out of the markets and
just stick it in CDs for awhile. Unfortunately, history shows that it is extremely
difficult to know when to get back in,
and that you’re likely to miss a major
portion of the next bull market by the
time you’re sure it has turned around.
That is why our ABFS growth strategies try to keep money in the market, but
apply disciplines to (a) take some money
off the table when markets get dicey, and
(b) get that money reinvested as soon as
conditions warrant. At this writing, our
strategies have quite a bit in cash (money
markets), and we’re already seeing opportunities to get some of your money
back to work.
Gain Wise, Loss Foolish
When you look at the past three
months in the graph below, the relatively
low volatility of our strategies shows its
value.
As we have discussed at length in
previous issues of On Balance, our emphasis on portfolio risk mitigation has
Value +
Tactical
Global Gr.
MoGro
Managed
Risk
Strategic
Global Gr.
Past 3 Months
- S&P 500 index down 14%
- ABFS growth strategies:
lower volatility, less decline
3
S&P 500
been frustrating at times these past few
years. An approach that forfeits some Past 12 Months
upside potential to protect against
-A Wild Ride, with
large portfolio losses can seem unnec- Relative Performance
essary when stock prices are rising.
Changing Frequently
We believe that the long-term impact of avoiding huge portfolio deStrategic
clines far outweighs any money “lost”
Global Gr.
by lagging the market during bull
MoGro
years (see page 7). Indeed, many people’s myopic obsession with never
“missing out” on the market’s gains is
somewhat “penny-wise and poundfoolish”—and can lead to devastating
losses during bear markets.
That approach is akin to trying to
S&P 500
save time in a car by keeping constant
pressure on the gas pedal, even on
sharp corners. Skidding off the road
could delay you far more than taking
your foot off the pedal temporarily in
tight corners.
The same is true with stock investing.
thing is possible, and whether it gets
The best way to reach your goals probathat ugly or not, we believe our apbly isn’t abandoning your vehicle
proach will serve you well.
(stocks) altogether; you just need to be
willing to “take your foot off the gas”
It’s All Relative
from time to time in precarious situations
The 12-month graph above plots
so you can safely reach your ultimate
our ABFS growth strategies against
destination.
the S&P 500 index (the black line)
We sometimes sound like a broken
through last week. First of all, notice
record on this topic (e.g., last quarter’s
how volatile the past year has been.
On Balance has an article subtitled,
Note also how the black line is
“Fixation on Keeping Up with the Marsometimes above the other lines (our
ket May Be Hazardous to Your
strategies), and at other times dips
Wealth”). But that’s because we have
below them. In part, that is simply
been concerned that when the next bear
because our strategies are generally
market finally arrived, many people
less volatile than the S&P 500 (they
would still have their foot on gas pedal,
don’t go up or down as rapidly).
as they did in 2000. Most investors tend
However, the graph also points out
to keep their money in stocks or funds
the difficulty with comparing performand just “hope for the best” (i.e., that
ance over short periods. Whether our
prices keep going up). Having ABFS
strategies appear to be doing a good
managing your equity portfolio, on the
job relative to the S&P 500 or not deother hand, means someone is paying
pends in large part on when you hapattention and adjusting speed/course
pen to look at them.
when the road ahead gets dangerous.
At the points on the graph when the
It is still a little too early to tell if reblack line is “beating” our strategies,
cent selling is the beginning of a proour management skills don’t seem all
tracted bear market like the one in 2000that impressive. Weeks later, on the
2002. Frankly, it would be unusual to
other hand, when the S&P 500 line
have two bear markets of that magnitude
falls (as it has recently), we suddenly
in a row (the S&P 500 lost roughly half
look smarter.
of its value in that bear market). But anyIn reality, we were no better or
4
Value +
Managed
Risk
Tactical
Global Gr.
S&P 500
worse managers at any of those points in
time. We were simply going about our
business as usual.
The fact of the matter is that we are
simply willing to be different than the
market. That also makes us different
from most other investment managers. In
the short run, that difference sometimes
causes us to underperform—and sometimes to do better.
The important thing is the investment
approach being employed in our strategies. That is what will determine the long
-term impact of our management on your
total portfolio. We think you can see that
impact on page 7 (which shows our
strategies’ results over a full bear and
bull market period).
In other words, the difference between good and bad relative performance
can change very quickly. It is easy to
lose sight of the forest (a sound longterm approach) by placing too much emphasis on the trees (short-term returns).
In the end, the important thing is investing in a way that lets you have confidence that you will reach your long-term
goals, but without making you vulnerable
to devastating portfolio set-backs.
Current Positions/Perspective
Most of our growth strategies finished
2007 with substantial amounts of cash
(money markets) and/or defensive positions designed to weather market declines
better than stocks in general. As a result,
our strategies have generally dropped
significantly less than the broad market
thus far in 2008, as you saw on the graph
on page 3.
With a few exceptions,* our growth
strategies utilize stop-loss disciplines to
limit losses on mutual fund and ETF
holdings. As selling has accelerated in
recent weeks, those stop-loss disciplines
have caused us to sell more things...and
raise more cash.
Higher cash reserves can be good for
several reasons. Most obvious is the fact
that, as prices continue falling, you are
“giving back” less of your gains than
people who are still fully invested.
Additionally, extra cash provides liquidity for buying back into the market at
lower prices when it seems “safe to go
back into the water” again. The challenge, of course, is determining when it is
time to do that. We actually made a few
purchases today (January 22nd), and if
bear market selling accelerates in coming
days/weeks, we may make some additional purchases in oversold segments of
the market.
We sometimes make “contrarian” or
bargain-hunting purchases. Not all of
them work out well...and even those that
do can take awhile. We actually made a
few small income-oriented purchases in
late 2007 to take advantage of turmoil in
the real estate and mortgage industries,
and those holdings subsequently fell further in value.
Although those declines reduced 2007
return figures, our diversification rules
limited the overall portfolio impact. In
* The Strategic Global Growth (SGG) strategy is
designed to remain fully invested, so it generally
does not raise cash or use stop-loss disciplines.
Stop-loss disciplines are also not used with most
individual income-oriented securities (stocks and
bonds), because the higher daily volatility of those
securities makes effective use of stop-losses more
problematic (stops are far more likely to be triggered during normal day-to-day price fluctuations
than with funds). We are generally willing to hold
individual companies’ income-oriented securities
through significant price declines, as long as we
still believe in their long-term potential contribution to the portfolio from those levels.
We have come across some good
estate planning topics lately. These
are topics you might want to discuss
with your ABFS advisor and your
estate planning attorney.
emption amount will drop all the way to
$1 million in 2011. Why not? Well, cynics might say it’s because that is low
enough to affect most members of Congress, so they will deem some increase in
the best interest of “the people.” But
whatever the reason, the exemption
amount will almost certainly be set
higher than $1 million in 2011 and beyond.
Expect a great deal of political posturing on this topic in 2009. Congress
will probably agree on some compromise. They might leave the exemption
amount at the 2009 level of $3.5 million.
Another possibility is that the amount
will be reduced to a lower level, but in
return, also lower the Federal estate tax
rate, for example from 45% to 40%.
The outcome of the November election will certainly impact those decisions. If the Democrats maintain control
of Congress and take over the White
House, future estate taxes will likely be
higher than if Republicans control either.
One thing seems certain, though; estate
tax calculations in 2010 and beyond will
not be what the law now says they’ll be.
Fate of Estate Tax Exemption
The Federal Estate Tax Exemption
Amount—the amount that can be
passed from one person to another at
death without Federal estate tax—is $2
million for anyone dying in 2008.
Substantial increases are scheduled for
the next two years. The exemption
amount is set to jump to $3.5 million
in 2009, and Federal estate taxes are
scheduled to be eliminated entirely in
2010. Unfortunately, the exemption
amount reappears in 2011 at the far
lower level of only $1 million.
There is considerable speculation
as to which of these changes will actually occur as scheduled. The 2009
increase in the exemption amount (to
$3.5 million) probably will occur, if
for no other reason than the fact that
legislators probably won’t have time
after the election to change it (no matter who wins the election).
From 2010 on, however, all bets
are off. Few experts expect Congress
to allow the estate tax to be totally
eliminated in 2010, as is currently
scheduled. That is viewed as simply
too much of a giveaway to the rich
(although one could argue that the
“cost” of getting the benefit—having
to die that year—is also pretty steep).
It is equally unlikely that the ex-
Make Gifts Early, Not in December
The annual gift “exclusion”—the
amount that can be gifted while you’re
living without requiring the filing of a
gift tax return—remains at $12,000 in
2008. A person can give $12,000
($24,000 for couples) to as many different people as they want without any gift
tax implications.
It is common for people with large
estates to make gifts to children and/or
grandchildren in December during the
holidays. However, if your estate is large
enough to warrant annual gifts to reduce
potential estate taxes, it makes more
sense to make those gifts earlier.
If you wait until December, you will
effectively be “giving” the IRS thousands of extra dollars in the year of your
death. That’s because the gifts you haven’t yet made that year will be part of
your estate and could be taxed at 45%.
You can avoid that problem and still
follow your normal “holiday” gifting
routine by giving the kids a card saying
they will be receiving a gift in January.
If you recently made your 2007 gifts
(in December), consider making another
gift for 2008 in the next few weeks. It
may seem like you’re making an “extra”
gift and that may seem strange. But in
fact that is exactly what you’re trying to
do—to get some “extra” money out of
fact, our management of the other
holdings in those portfolios generally
still resulted in less portfolio decline
over these past few months than if the
accounts had simply been invested in
typical stock funds. It is a good example of how diversification and sound
management disciplines can overcome
one or two bad investments.
Looking forward, 2008 will undoubtedly provide additional challenges. As politicians argue and the
Fed tries to stave off recession, we
will be watching over your investments—limiting your exposure to
negative developments, while attempting to take advantage of emerging
opportunities. Ƈ
Estate Planning Matters
5
your estate so it isn’t subject to tax.
By the way, if annual gifting makes
estate planning sense, but you’re uncomfortable giving your children and/or
grandchildren cash (e.g., because you
think they’ll spend it frivolously), consider using the gift amount (or part of it)
to pay down the principal on their mortgage. Just ask them for the bank address
and their mortgage account number, and
send the money directly to the bank. It
increases their home equity, shortens the
time until the mortgage is paid off, and
they don’t suddenly feel flush with cash.
How to Exceed the $12,000 Limit
If you are already maximizing your
$12,000 per person gifts to your children
and/or grandchildren, and would like to
help them out even more, there are ways
to do so. One of the easiest is to take
advantage of the fact that you are allowed to pay tuition and medical expenses (including health insurance) in
addition to the $12,000 per year gift
allowance per person.
In order to do so, remember that you
must write the checks for tuition and
medical expenses directly to schools,
doctors, hospitals, etc. You are not allowed to give the money to your kids
and let them make the payments.
Give Them Some Advice, Too
This is a good opportunity to reiterate
the importance of grown children having
(at a minimum) a simple will. Most of
you have done considerable estate planning, including wills and in many cases
trusts as well. But your children may be
young enough that they aren’t thinking
of estate planning (remember, we all
thought we’d live forever at that age!).
Even if your grown children have few
(or no) assets, it is important that they
have wills, especially if they have children. The reason is simple: no one
knows the circumstances of their own
death. If they were killed in an act of
gross negligence, their death (and therefore their children) could suddenly be
“worth” millions of dollars.
That kind of money can make distant
relatives suddenly come out of the
woodwork to ask courts for guardianship
of children (and control of all that
money). Verbally asking someone to
look after your child does not carry the
same weight as stating that wish in a
legal will. While there are no guarantees,
courts generally weigh heavily a parent’s
wishes in their will regarding guardian-
ship of children.
If your grown children don’t feel
that they can afford a will, offer to pay
for it for them. It should only cost a
few hundred dollars ($300 seems common), and it could be some of the best
money you’ll spend.
A Matter of Trust
Leaving money to children in trust,
rather than to the children themselves,
is a growing trend. Although creating
a trust for each child may seem like an
unnecessary complication, many parents are doing so because they fear
that money left directly to children
may end up subject to creditors’
You can effectively create a
prenuptial agreement (for those
assets) without your child ever
having to raise that often-awkward
topic with their fiancée/spouse.
claims, or more specifically exspouses in the case of divorce.
An adult child can have virtually
complete control over such a trust,
with access to both income and principal as needed, but the trust keeps those
assets out of the direct reach of others.
It can stipulate that any money not
used by the child ultimately passes to
the grandchildren.
An advantage of this approach is
that you effectively create a prenuptial
agreement (for those assets) without
your child ever having to raise that
often-awkward topic with their fiancée/spouse. If a marriage ends in divorce, a trust can at least protect the
assets you leave to your child.
Charitable Intent
+ Grandkids = HEET
Want to help fund education &
healthcare costs for your grandchildren or great-grandchildren, make a
significant charitable donation and at
the same time reduce the size of your
taxable estate? Affluent investors with
charitable intentions are increasingly
using a lesser-known estate-planning
tool called a HEET (Health & Education Exclusion Trust) to assist them in
this objective. Unlike many legacy
strategies, the HEET has no limit on
how much money can be put into it,
and it can be funded while living or as
a testamentary gift at death.
For grandparents, the key benefit of
the HEET is avoidance of the heavy
6
45% Generation Skipping Tax
(GST). Money from the HEET can be
used to fund all levels of education, even
including such things as ballet and karate
lessons. The trust can also be used to
fund any healthcare expenses, including
medical insurance.
Simply put, the HEET pays 80-90%
to the beneficiaries, which can be as nonspecific as “all of my future great grandchildren.” The remaining 10-20% goes to
qualified charities of your choosing.
When sufficiently funded, a HEET can
cover education and healthcare expenses
for several generations, and at the same
time make substantial annual gifts to
your favorite charities.
A Family Affair
We are increasingly finding it beneficial to have grown children in discussions with our clients. While each person
needs to decide when they believe it is
the right time to include their grown children in financial matters, we want you to
know that we welcome such “family”
meetings.
One problem with failing to include
adult children in discussions of your financial matters is that, at some point,
they may feel compelled to raise the subject themselves. That can be awkward,
since they don’t want you to think they
are money-hungry or anxious for you to
die. They may simply be concerned
about you, or want to avoid suddenly
having to scramble to figure things out
after you are gone.
Rather than waiting until they feel a
need to raise the issue, it makes more
sense for you to do so at some point.
When that time comes, you might consider occasionally inviting them to join
you in a meeting with your ABFS advisor. It can give them a better sense what
it really costs to maintain your lifestyle,
and how we are helping plan for your
future financial needs. It can be comforting to them to know that you are financially secure. It also introduces them to
ABFS and our emphasis on discipline
and planning. Finally, it may help you
feel more comfortable that they will be
good stewards over the assets you have
spent a lifetime accumulating.
You know your children, and which
ones (if any) are responsible enough to
include in discussions of your financial
affairs. If you have questions, talk with
your ABFS advisor. We will help integrate your grown children in your plans
whenever you feel the time is right. Ƈ
PERFORMANCE OF ABFS GROWTH STRATEGIES
Inception through December 31, 2007 1
ACTUAL RETURNS (Client Accounts)
Cumulative (1/1/99-12/31/07)
Value of $100,000
1
ABFS Strategies
Momentum Growth
2
$234,234
1999
+50.4%
2000
+5.5%
Value Plus
$240,182
+26.4%
+16.8%
Managed Risk
$224,775
Investment
Strategic Global Growth $170 ,791
+22.9% +15.7%
1
1
1
Component Returns for Each Year 2
2001
2002
2003
2004
2005
+5.5%
-1.7%
+19.0% +7.3% +3.6%
2006
+5.6%
2007
+1.9%
+9.5%
+0.7%
+14.0%
+7.0%
+5.2%
+9.5%
+5.0%
+13.8%
+3.8%
+12.7%
+2.7%
+2.9% +10.7%
+1.5%
_
n/a
-5.4%
+6.9%
-4.1%
+20.1%
+14.4%
+8.2% +12.5%
+5.3%
+11.8%
+13.1%
+3.9% +10.2%
+3.3%
+28.5% +10.7%
+50.0%
+8.6%
+4.8% +15.7%
+1.4% +9.5%
+5.4%
+9.8%
Tactical Global Growth
$154,6291
n/a1
n/a1
+3.6%
-0.2%
Indexes
Vanguard Index 500
NASDAQ
$137,011
$120,923
+21.1%
+85.6%
-9.1%
-39.3%
-12.0%
-21.1%
-22.2%
-31.5%
SUPPLEMENTAL “MODEL PORTFOLIO” INFORMATION 3
RISK/VOLATILITY3
Value Plus
Managed Risk
Momentum Gr.
Strategic Global Growth
Tactical Global Growth1
Vanguard Index 500
NASDAQ
SD
MDD
2.0%
1.6%
2.3%
2.0%
1.5%
5.1%
8.4%
-9.1%
-6.3%
-16.8%
-14.7%
-19.2%
-47.5%
-77.9%
FOOTNOTES
1
2
3
The first three ABFS strategies have existed under their current approach and trading disciplines since the end of 1998 (the entire graph period). Strategic
Global Growth (SGG) and Tactical Global Growth (TGG) began in early 2000, so their first full-year returns were in 2000 and 2001, respectively. The
only strategy not shown on the graph is TGG; it is excluded only because the software used to produce the graph is limited to showing six lines at a time.
Yearly “component” return figures are actual net returns to clients after all fees and expenses. “Cumulative Value of $100,000 Investment” includes the
returns in all individual “component” periods (same as graph period, except for SGG and TGG, which only have data from 2000/2001 on), compounded
at the end of each year or partial year shown under “component” periods.
The supplemental Model Portfolio information (graph and risk/volatility data) attempts to reflect the same mix and proportions of mutual funds purchased
for clients, adjusted daily for purchases and sales made in actual client accounts. While these data, created using FastTrack computer software, roughly
reflect fluctuations in actual client accounts, they are not drawn from actual account values, and therefore do not represent actual trading (whereas the
“Actual Returns” in the table above do). See additional limitations and disclosures regarding Model Portfolio data on page 8. All data on this sheet for
the NASDAQ and Vanguard Index 500 (a mutual fund based on the S&P 500 index) are actual data.
Risk/Volatility Measures (larger numbers = higher volatility/risk) for the entire graph period:
SD = monthly standard deviation of return.
MDD = maximum draw-down in account value from any high point to subsequent low point during the graph period.
This is the worst decline in value “endured” in order to achieve each investment’s return.
IMPORTANT: The above is not complete without notes and disclosures on page 8
7
Notes Regarding ABFS Growth Strategy Performance (on page 7)
GENERAL
The data and graph on page 7 are for informational purposes only. Proper interpretation requires some knowledge of market risks, returns and portfolio
theory. This information is best used by professionals, and the general public should not act based on it without substantial explanation, qualification, and
discussion. We believe – but do not guarantee – that these data are accurate. Of course, there is no assurance that future returns, declines, or volatility will in
any way resemble the past, or that results will even be profitable. We do not intend to imply that high relative returns will be produced on an ongoing basis,
and periods of negative returns should be expected. Investors should be prepared to endure such periods, and should be sure money invested in growth portfolios is of a long-term nature (not needed for at least 5-10 years).
The first three ABFS growth strategies shown (Momentum Growth, Value Plus and Managed Risk—or their predecessors, which were also created and managed by Robert Pennell, the current primary growth manager) have existed for more than twenty years. However, their methodology has evolved and
changed significantly over the years, and a major modification occurred in late 1998. This modification included the implementation of much stricter sell
disciplines intended to help optimize risk-adjusted returns and reduce absolute downside exposure. Because of the significance of the change in late 1998,
we believe only the performance since then is representative of these strategies’ current management style, and hence only that period is shown. The last
two ABFS strategies shown—the Strategic Global Growth (SGG) and Tactical Global Growth (TGG), previously known as Index Plus:non-timed and
timed, respectively—have only existed since 2000; their first full years of client data are 2000 and 2001, respectively. Due to these limited track records,
investment decisions should not be based solely on these results. Investors should make sure they fully understand and agree with each management style
utilized. Due to use of stop-loss disciplines in all strategies except SGG, much of the return in these strategies is expected to be short-term capital gains,
making these strategies most attractive for tax-sheltered accounts and/or clients wishing to reduce exposure to large declines, not taxable investors concerned
with minimizing taxes.
RETURNS
Returns for ABFS strategies are “iterative internal rate of return” (1999-2005) and “time weighted rate of return” (after 2005) figures for actual client portfolios. The figures for each component period include all client accounts (even new and terminated ones) that were invested in that strategy for the entirety of
that calendar year (partial year for the latest component period when less than a full year), but exclude any non-managed securities (which were occasionally
held at clients’ request) in those accounts. We have used the returns for all clients invested in a each strategy for each full year, rather than only results for
clients invested since the beginning, because ABFS has generally had more clients in each strategy each year. Thus, we believe that calculating the returns
including all clients invested for each full year (rather than only those in the strategy “from the beginning”) provides larger samples, and is therefore more
representative of the returns generally achieved for clients each year. Cumulative “Value of $100,000 Investment” is calculated by simply compounding
actual returns for the component periods at the end of each year. Note that for SGG and TGG, all data are for a shorter period than for the other three strategies, due to their later introduction. Returns are calculated on a dollar-weighted basis; that is, they include the actual beginning values, all expenses
(including management fees and transaction costs), and deposits and withdrawals for all accounts, calculated as one large “portfolio” for each strategy. Returns are therefore net of all fees and transaction charges, and include reinvestment of all dividends and earnings. Returns ignore tax implications, which may
be a significant consideration for taxable accounts. Actual individual client returns differ somewhat, depending on such factors as each client’s beginning
date, transaction costs (which vary by account size), additions and withdrawals during the period, etc. Data for the “Vanguard Index 500” Fund (VFINX),
an “index” fund based on the S&P 500 index, are total return, including dividends. “NASDAQ” data are for the NASDAQ Composite index price only.
MODEL PORTFOLIO DATA
Graph
As stated above, the return figures in the data table represent trading in actual client accounts. The colored mountain-type graph and the risk/volatility data,
on the other hand, are based on a model portfolio with approximately the same mix and proportions of mutual funds held for clients, adjusted daily for purchases and sales made in actual client accounts. The only strategy not shown on the graph is TGG, and its exclusion is only because the FastTrack software
used to produce the graph is limited to graphing six lines at a time. Model portfolio data take into account a model portfolio fee, but because they are not
drawn from actual account values, they do not represent actual trading in client accounts (as the “Actual Return” figures in the table do). Model trading is
subject to various limitations. It does not involve financial risk and cannot completely account for the impact of financial risk involved with actual trading.
Model trading or model performance may not reflect the impact that material economic and market factors might have had on the management of actual
client accounts. The performance results of a model portfolio do not reflect actual investors’ ability to withstand losses or to adhere to a particular trading
strategy in spite of trading losses, which can adversely affect actual trading performance (results). Therefore, while we believe the graph and risk/volatility
measures provide a rough approximation of ABFS strategy fluctuations, they are not meant to precisely represent the fluctuations in every ABFS account or
take the place of the actual account returns reflected in the table above the graph. Note that the Managed Risk strategy contains individual income-oriented
securities as well as funds. Since the graph reflects only mutual funds, mutual funds (e.g., short-term bond funds) were used to represent those other securities. This substitution is not to imply that such securities and the funds used are equivalent (the individual securities are in fact often riskier), but rather to
somehow attempt to account for them in the graph. Note that the “Actual Return” figures in the table above the graph do reflect Managed Risk clients’ actual
holdings (including all individual securities), so they do incorporate the actual impact of those securities on returns.
Risk/Volatility Measures
Generally, investment analysts measure portfolio risk using some type of volatility measure that includes both realized and unrealized (paper) gains and
losses. Two such volatility figures are shown for the model portfolio in the accompanying table:
SD = monthly standard deviation of return for the period. SD reflects the range of variation in return, both up and down.
MDD = maximum draw-down (decline) in account value from any high point to subsequent low point during the period. Unlike SD, MDD focuses only on
downside fluctuation (which some people consider more useful as a measure of risk than fluctuation up and down). In essence, MDD shows the worst
decline in value “endured” during the period in order to achieve the resulting return.
Although SD and MDD figures relate to each strategy’s volatility and declines during the periods shown, they cannot indicate all types or amounts of risk
taken in each strategy, and how those risks differ from the S&P 500 or NASDAQ indexes. For example, the S&P 500 is an index of U.S. large company
stocks. ABFS growth strategies, while primarily utilizing mutual funds containing stocks, often employ funds containing types of securities different than the
S&P 500, such as small company stocks, foreign stocks, domestic or foreign bonds, convertible securities, and/or cash equivalents. The Managed Risk strategy may also contain individual income-oriented securities in addition to mutual funds. We believe the flexibility to use a wide variety of securities and
market sectors facilitates enhanced risk-adjusted performance, but investors should be aware that individual holdings purchased in these strategies may have
substantially different (and greater) risks than the S&P 500 and/or NASDAQ, and that direct comparison with these or any other indexes is not possible. The
comparisons to these indexes in the table and graph are only meant to provide a general idea of relative return and volatility, and should not be taken to imply that ABFS strategies are actually similar to VFINX, the S&P 500, the NASDAQ, or any other index or investment.
ABFSDGPDisc012008
8
^ééêçéêá~íÉ=_~ä~åÅÉ=cáå~åÅá~ä=pÉêîáÅÉëI=fåÅK=
fk`ljb=pb`rofqfbp=mbocloj^k`b=(1)
As of 12/31/07=
ANNUAL RETURNS (2)
GROWTH OF $100,000 (1/1/03—12/31/07)
ABFS Income Securities Strategy(2)
Citi Gov/Corp 1-10 yr (Total Return)(3)
$137,061
$122,619
ABFS
Citi Gov/Corp 1-10yr(3)
(Total Return)
Income Securities
Year
$140,000
$135,000
$130,000
2007
2.3%
7.4%
2006
7.6%
4.2%
2005
1.1%
1.6%
2004
5.9%
3.1%
$125,000
2003
16.3%
4.6%
$120,000
5-yr Annualized
8.0%
5.1%
20.0%
$115,000
15.0%
$110,000
10.0%
$105,000
5.0%
0.0%
$100,000
2003
2004
2005
2006
2007
2003
2004
2005
2006
2007
fk`ljb=pb`rofqfbp=abp`ofmqflk=
OBJECTIVES
x Preservation and stability of overall portfolio principal4
x Maximization of income in keeping with first objective
x Capital appreciation
TOOLS AND TECHNIQUES
x Evaluation of major economic trends, especially inflation
and interest rate trends
x Tactical Allocation within each portfolio
x Utilization of “fixed principal” investments as well as
“marketable securities” with varying maturities/durations
to control exposure to interest rates
x Diversification through the use of convertible bonds,
preferred stocks, specialty mutual funds, and ETFs
TAXABLE ACCOUNTS (INDIVIDUAL, JOINT, TRUST, ETC.)
x Federal tax-sensitive only: Municipal securities will be used in
taxable accounts where clients are expected to be in high marginal federal tax brackets, though the ultimate objective focuses
on “net after-tax” return5
x Federal and state tax-sensitive: Municipal securities exempt
from both federal and state income tax will be utilized for clients
residing in states where applicable—again, the best “net after-tax”
return is sought5
x Corporate and/or government securities may be used when
accounts are not tax-sensitive, or when such securities
provide higher after-tax returns than municipals.
TAX-DEFERRED ACCOUNTS (PENSION, PROFIT SHARING, IRAS, ETC.)
x Corporate and/or government securities are utilized
(no municipals)
MANAGERS’ COMMENTARY
The cornerstone of our approach is a steady income yield with limited principal exposure to interest rate fluctuations. We accomplish this by
keeping a majority of the portfolio in “investment grade” securities and bank CDs with relatively short (1-8 year) maturities/durations.
In addition, we strive to augment returns by using a combination of no-load mutual funds and individual securities with capital appreciation
potential. Individual securities may include bonds, preferred and/or other high-yielding stocks, and/or convertible securities. We particularly
like to use short-to-intermediate-term convertible bonds when we can find them at prices we deem “undervalued.”
FOOTNOTES
1
2
3
4
5
Past Performance is no guarantee of future results. The above description is for informational purposes only, and is part of the investment advisor’s management agreement. There is no
assurance, either express or implied, that these portfolio objectives can or will be met, or that specific investment performance will result. It is expected that participants will incur actual
losses from time to time. All services are on a best effort basis.
“Annual Returns” are actual net returns to clients after all fees and expenses. “Growth of $100,000” is calculated by taking the returns shown under “Annual
Returns” for each component period and compounding them at the end of each year, or partial year, shown.
All data on this sheet for the Citigroup Gov/Corp 1-10yr (Total Return) index are actual data. The Citigroup Gov/Corp 1-10yr (Total Return) index is a broad based, unmanaged
index of corporate and U.S. Treasury securities that represents short-to-intermediate term bonds commonly used (e.g. in a “laddered” bond portfolio) for accounts with an income
oriented investment objective. Please note that an investor cannot invest directly in an index; it is provided only as a point of reference.
Individual holdings are expected to fluctuate in value, but the objective is to preserve the value of the overall account.
Some taxable securities will be utilized when it is believed they will produce a better “net after-tax” return than tax-exempt securities.
(SEE ADDITIONAL DISCLOSURES ON REVERSE SIDE)
NOTES REGARDING ABFS INCOME SECURITIES STRATEGY PERFORMANCE (ON REVERSE PAGE)
INVESTMENT MINIMUM: $100,000
FEE SCHEDULE: 0.60% on first $500,000 and 0.40% on any portion over $500,000
GENERAL
The data and graph on this sheet are for informational purposes only. Proper interpretation requires some knowledge of
market risks, returns, and portfolio theory. Investors should not act based on it without substantial explanation, qualification, and discussion. We believe – but do not guarantee – that these data are accurate. Of course, there is no assurance
that future returns will in any way resemble the past, or that results will even be profitable. We do not intend to imply
that high relative returns will be produced on an ongoing basis, and periods of low, or possibly even negative, returns
should be expected. Investors should be prepared to endure such periods, and should be sure money invested in income
portfolios is of a long-term nature (i.e., that substantial withdrawals of principal are not anticipated for 3-5 years).
The investment objective for the Income Securities strategy is to maximize current income consistent with preservation
of capital. Assets with capital appreciation characteristics may be used, but appreciation is less important than income
and overall stability of principal. The strategy may hold individual bonds, individual dividend paying stocks, income
oriented mutual funds, exchange traded funds, individual convertible bonds, and other income oriented securities. We
believe the flexibility to use a wide variety of securities facilitates enhanced risk-adjusted performance, but investors
should be aware that individual holdings purchased in these strategies may have substantially different (and greater)
risks than the Citigroup Gov/Corp 1-10yr (Total Return) index, and that direct comparison with this or any other index is
not possible. The comparisons to this index in the table and graph are only meant to provide a general idea of relative
return, and should not be taken to imply that ABFS’s Income Securities strategy is actually similar to the Citigroup Gov/
Corp 1-10yr (Total Return) index, or any other index or investment.
RETURNS
The return figures for each annual period include all client accounts (even new and terminated ones) that were invested
in that strategy for the entirety of that calendar year (partial year for the latest component period when less than a full
year), but exclude any non-managed securities (which were occasionally held at clients’ request) in those accounts. We
have used the returns for all clients invested in each strategy for each full year, rather than only results for clients invested since the beginning, because ABFS has had more clients in this strategy each year. Thus, we believe that calculating the returns including all clients invested for each full year (rather than only those in the strategy “from the beginning”) provides a larger sample of returns, and is therefore more representative of the actual returns experienced by clients each year. “Growth of $100,000” is calculated by simply compounding actual returns for the component periods at
the end of each year. “5-yr Annualized” is the annual rate of return calculated from that “Growth of $100,000”. Returns
are calculated on a dollar-weighted basis; that is, they include the actual beginning values, all expenses (including management fees and transaction costs), and deposits and withdrawals for all accounts, calculated as one large “portfolio.”
Returns are therefore net of all fees and transaction charges, and include reinvestment of dividends and earnings. Returns
ignore tax implications, which may be a significant consideration for taxable accounts. Actual individual client returns
usually differ somewhat, depending on such factors as each client’s beginning date, transaction costs (which vary by
account size), re-investment of dividends, etc. Returns also vary due to the exceptions noted in the next paragraph. Data
for the “Citigroup Gov/Corp 1-10yr” index are based on the total return of short-to-intermediate term corporate and government bonds, assuming reinvestment of all interest income.
In 2005, ABFS changed the portfolio accounting software we use to track and calculate investment performance. This
has resulted in several differences between the way annual returns were calculated through 2005 and after 2005. First,
returns through 2005 are “iterative internal rates of return” (IRR’s) while returns after 2005 are “time weighted rates of
return” (TWR’s). Both methodologies are widely used, and are, we believe, indicative of this strategy’s results. Also,
through 2005, accounts containing tax-exempt municipal securities were excluded from composite return calculations.
At the time, we felt this would provide a more meaningful comparison of our pre-tax performance with taxable alternatives, such as the Citigroup index shown. However, our software change made it impractical to continue excluding these
accounts, so Income Securities return figures after 2005 include accounts with municipal securities, even though taxexempt yields are typically lower and may reduce our annual return figures somewhat. Lastly, through 2005, a small
number of fixed annuities, representing less than 2% of assets in the Income Securities strategy, were included in the
composite returns. Those annuities had the effect of slightly dragging down the overall return in 2003, slightly increasing it in 2005, and had minimal effect in 2004. Fixed annuities are not included in returns after 2005. We do not believe
any of these changes distorts return figures so as to invalidate a general comparison with the index shown.