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The following 55+ pages represent a summary of relevant information from the first quarter of 2008.
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Copyright © 2008 by Institute of Business & Finance. All rights reserved. v1.0
INSTITUTE OF BUSINESS & FINANCE
QUARTERLY UPDATES
Q1 2008
Quarterly Updates
Table of Contents
MFS, ETFS & ETNS
HOW VANGUARD RANKS 1.1
ETNS 1.1
MONEY MARKET FUNDS 1.1
TOP 10 ETFS 1.2
ETF EXPENSE RATIOS 1.2
U.S. STOCKS
U.S. STOCK MARKET VOLATILITY 2.1
THE 20 LARGEST U.S. COMPANIES 2.2
DOW JONES INDUSTRIAL AVERAGE 2.2
S&P 500: NO GAIN IN 9 YEARS 2.3
S&P 500 VOLATILITY 2.4
STOCK MARKET DECLINES [1900-2008] 2.5
S&P 500 RETURNS AFTER RECESSION LOWS 2.5
S&P 500 DIVIDENDS 2.6
U.S. STOCK RETURNS (2007) 2.7
RETIREMENT
ROTH IRA VS. TRADITIONAL IRA 3.1
5% ANNUAL WITHDRAWAL PORTFOLIOS 3.1
ANNUITIES
EXTREMELY LOW COST VARIABLE ANNUITY 4.1
SUBSTANDARD ANNUITIZATION 4.1
GLOBAL INVESTING
GLOBAL ECONOMICS 5.1
COUNTRIES HOLDING U.S. DEBT 5.1
FRONTIER INDEX 5.1
GLOBAL STOCK RETURNS 5.2
FINANCIAL PLANNING
BRIEF HISTORY OF RATING AGENCIES 6.1
CLOSED-END FUND 2008 DISCOUNTS 6.1
HOW CREDIT SCORES ARE DETERMINED 6.1
GIFTS AND QUALIFYING FOR MEDICAID 6.2
SOCIAL SECURITY SPOUSAL BENEFITS 6.3
DEFINING A RECESSION 6.4
OIL O’PLENTY 6.4
HEALTH CARE COSTS 6.4
RECESSION AND OTHER CONCERNS 6.5
REAL ESTATE
HOME OWNERSHIP AS AN INVESTMENT 7.1
MORTGAGE IMPACT REDUCTION 7.1
REVERSE MORTGAGE CALCULATOR 7.2
BONDS
MUNICIPAL BOND INSURANCE 8.1
THE ECONOMY
U.S. RECEIPTS AND DISPERSEMENTS 9.1
U.S. CREDIT CRUNCH AND BANKS 9.1
QUARTERLY UPDATES
MFS, ETFS & ETNS
MUTUAL FUNDS & ETNS. 1.1
QUARTERLY UPDATES
IBF | GRADUATE SERIES
1.HOW VANGUARD RANKS
The table below, provided by Vanguard and data from Lipper, shows what percentage of
Vanguard funds beat their peer group averages for the periods ending December 31st,
2007. As you can see, the group did extremely well in the case of bond funds but had
much less impressive results with equities.
Vanguard Peer Group Rankings as of 12-31-2007
1 Year 3 Years 5 Years 10 Years
Stock funds 40% 67% 77% 66%
Balanced funds 73% 70% 57% 89%
Bond funds 97% 96% 96% 100%
Money market funds 100% 100% 100% 100%
All Vanguard funds 60% 77% 83% 83%
ETNS
It appears that exchange-traded notes (ETNs) may be a better investment vehicle than
ETFs for certain illiquid securities, such as commodities and alternative-asset classes.
For advisors, knowing the difference is important since several sectors can be purchased
either as an ETN or ETF. With an ETF, your clients are buying shares that represent a
fractional ownership of a portfolio, similar to owning shares of a mutual fund.
ETNs are long-term debt securities that promise to pay investors the return of a particular
index, minus fees. ETN investors have an additional concern, credit risk. The issuer of
the ETN must be solvent when the investor wants to sell shares or when such shares
reach maturity. An advantage of the ETN over the ETF is that it shifts any index tracking
error to the issuer, not the investor. Like ETFs, ETNs can be sold short.
MONEY MARKET FUNDS
By the end of the first quarter of 2008, $3.4 trillion was invested in money market funds.
By regulation, money market funds are required to disclose their holdings at least once
every six months; other types of mutual funds must do so every three months.
MUTUAL FUNDS & ETNS. 1.2
QUARTERLY UPDATES
IBF | GRADUATE SERIES
TOP 10 ETFS
The first table below shows the 10 largest ETFs, as measured by daily market activity;
the second table ranks the 10 largest ETF by asset size (shown in billions of U.S. dollars).
10 Most Actively-Traded ETFs [April 2008]
S&P 500 SPDR (SPY) iShares MSCI-Japan (EWJ)
Nasdaq-100 Index Stock (QQQQ) iShares MSCI EM (EEM)
Financial Select Sector SPDR (XLF) Utrashort S&P 500 Proshares (SDS)
iShares Russell (IWM) Energy Selector Sector SPDR (XLE)
Ultrashort QQQ Proshares (QID) Dow Diamonds – DJIA (DIA)
10 Largest ETFs [April 2008]
S&P 500 SPDR ($85b) iShares S&P 500 ($18b)
iShares MSCI EAFE ($48b) iShares Russell 1000 Growth ($14b)
iShares MSCI EM ($24b) Vanguard Total Market VIPER ($10b)
streetTRACKS Gold Trust ($19b) iShares Lehman 1-3 Tres. Bond ($10b)
Nasdaq—100 Index Stock ($19b) iShares Russell 2000 ($10b)
ETF EXPENSE RATIOS
The table below shows the average expense ratio for 12 different ETF categories, as of
April 2008.
ETF Category Expense Ratios [April 2008]
Broad Market Indexes (0.38%) Global & Foreign Indexes (0.58%)
Large Cap Indexes (0.28%) Emerging Markets Indexes (0.60%)
Mid Cap Indexes (0.25%) Fixed Income Indexes (0.20%)
Small Cap Indexes (0.33%) Commodity (0.75%)
Industry & Sector Indexes (0.50%) Currency (0.40%)
Specialty (0.95%)
QUARTERLY UPDATES
U.S. STOCKS
U.S. STOCKS 2.1
QUARTERLY UPDATES
IBF | GRADUATE SERIES
2.U.S. STOCK MARKET VOLATILITY
Average daily price swings for the Dow Jones U.S. Total Market Index were more than
50% greater in 2007 than in 2006, as measured by standard deviation. Surprisingly,
volatility in 2007 was still well below the 10-year average from 1998-2007; six of the
past 10 years were more volatile than 2007. From the beginning of 1998 to the end of
2007, standard deviation for the index ranged from a low of roughly 10% (2004, 2005
and 2006) to a high of over 25% (2002).
Advisors who are looking for equities that have low correlation, as measured by R-
squared, to the overall U.S. stock market should consider the following sectors (listed
from low to high):
Sectors with Low Correlation to U.S. Stock Market: 2003-2007
(R-squared)
Travel & Tourism (2%) Automobiles & Parts (19%)
Pharmaceuticals (5%) Specialized Consumer Services (20%)
Insurance Brokers (6%) Retailers (broadline) (26%)
Home Construction (6%) Personal Products (27%)
Forestry & Paper (8%) Semiconductors (31%)
The reasons for the low correlations are straightforward. For example, pharmaceutical
profits are not tied as much to the overall economy as the prospects for a specific drug.
Similarly, cyclicals and capital-intensive sectors such as autos, forestry, paper and
semiconductors can deviate substantially from overall domestic market returns. These
―maverick‖ sectors can be quite useful when diversifying a stock portfolio since they tend
not to move with the market as a whole.
For advisors who have clients that do not like ―tracking error‖ (doing something the
market is not), consider the following sectors, all of which have an R-squared of between
95% and 99%:
U.S. STOCKS 2.2
QUARTERLY UPDATES
IBF | GRADUATE SERIES
Sectors with Very High Correlation to U.S. Stock Market: 2003-2007
(R-squared of 95-99%)
Commercial Vehicles Restaurants & Bars
Waste & Disposal Services Electric Utilities
Medical Supplies Clothing & Accessories
Electronic Equipment Life Insurance
Aerospace & Defense Industrial Services
THE 20 LARGEST U.S. COMPANIES
The table below shows the 20 largest U.S. companies, as measured by stock market
capitalization as of the end of 2007 (source: Dow Jones). The market capitalization of
each is shown in parentheses (in billions).
2007 Largest U.S. Companies
Exxon Mobil ($504b) Cisco Systems ($165b)
GE ($375b) Google Class A ($163b)
Microsoft ($334b) Altria Group ($159b)
AT&T ($253b) Pfizer ($155b)
Proctor & Gamble ($228b) Intel ($155b)
Chevron ($195b) AIG ($149b)
Johnson & Johnson ($191b) J.P. Morgan Chase ($148b)
Wal-Mart Stores ($189b) IBM ($148b)
Bank of America ($186b) Citigroup ($146b)
Apple ($173b) Coca-Cola ($142b)
DOW JONES INDUSTRIAL AVERAGE
On February 19th
, 2008 the Dow Jones Industrial Average (DJIA) replaced two stocks
and added two new companies. Gone are Altria Group with a market cap of $153 billion
and Honeywell International with a market cap of $40 billion. Atria had been part of the
Dow since 1985, Honeywell since 1925. The new companies are Bank of America
($190 billion) and Chevron ($169 billion). By stock market value, Bank of America
was the largest U.S. bank and Chevron the second largest U.S. oil company after Exxon
Mobil. Chevron has been in the DJIA twice before, the first time as Standard Oil of
California (1924-1925).
U.S. STOCKS 2.3
QUARTERLY UPDATES
IBF | GRADUATE SERIES
The Dow was originally comprised of 12 ―smokestack‖ companies when it was first
published on May 26th
, 1896; it has been a 30-stock average since 1928. These changes to
the Dow mark the first time the 111-year old average has made a change since 2004. The
substitutions were made by the managing editor of The Wall Street Journal, which is
owned by News Corporation. The table below lists the 30 stocks that make up the Dow,
along with their stock symbol (shown in parentheses), the date the stock became part of
the average and market value (shown in billions of dollars), as of February 11th
, 2008.
2008 Dow Jones Industrial Average
Exxon Mobil (XOM)
1928-present
$446b IBM (IBM)
1932-39; 1979-present
$141b
General Electric (GE)
1896-98; 1899-1901; 1907-present
$342b Hewlett-Packard (HPQ)
1997-present
$108b
Microsoft (MSFT)
1999-present
$238b Verizon Commun. (VZ)
2004-present
$106b
AT&T (T)
1916-28; 1939-2004; 1999-present
$222b Merck (MRK)
1979-present
$97b
Proctor & Gamble (PG)
1932-present
$202b McDonald’s (MCD)
1985-present
$67b
Bank of America (BAC)
2008-present
$190b United Technologies (UTX)
1933-34; 1939-present
$65b
Johnson & Johnson (JNJ)
1997-present
$177b Walt Disney (DIS)
1991-present
$57b
Chevron (CVX)
2008-present
$169b Boeing (BA)
1987-present
$55b
Pfizer (PFE)
2004-present
$152b 3M (MMM)
1976-present
$52b
J.P. Morgan Chase (JPM)
1991-present
$148b Home Depot (HD)
1999-present
$47b
Citigroup (C)
1997-present
$134b American Express (AXP)
1982-present
$47b
Coca-Cola (KO)
1932-35; 1987 present
$126b Caterpillar (CAT)
1991-present
$44b
Wal-Mart Stores (WMT)
1997-present
$122b DuPont (DD)
1924-25; 1935-present
$41b
Intel (INTC)
1999-present
$118b Alcoa (AA)
1959-present
$29b
AIG (AIG)
2004-present
$113b General Motors (GM)
1915-16; 1925-present
$13b
S&P 500: NO GAIN IN 9 YEARS
U.S. STOCKS 2.4
QUARTERLY UPDATES
IBF | GRADUATE SERIES
According to the March 26th
, 2008 issue of The Wall Street Journal, the S&P 500, which
represents about half of the $1 trillion invested in index funds, ended the previous day at
1,353—slightly below the 1,363 mark it reached in April 1999. If you factor in dividends
and inflation, the S&P 500 has risen an average of just 1.3% a year over the past 10
years. For the past nine years, the index has fallen 0.4% a year; 1.4% a year over the past
eight years. Over the past nine years, the S&P 500 has underperformed commodities,
REITs, gold, foreign stocks and even U.S. Treasury bills (+4.7% a year). While stocks
are down since 1999, they are up since mid-2001. Shiller also believes that home values
will continue to weaken for years.
Shiller calculates that the S&P 500 traded in the late 1990s at more than 40 times its
component companies’ profits, far above the historical norm of 16. As of March
2008, the S&P 500 is trading at more than 20 times profits. The Dow Jones Industrial
Average, which contains fewer technology stocks, has risen less than 1% a year since
January 2000.
Yale economist Robert Shiller, who predicted stock market troubles in his 2000 book,
Irrational Exuberance, believes that excesses still exist. Richard Sylla of New York
University points out that since 1800, when there have been exceptional gains in stocks
(late 1810s, early 1820s, the 1840s, the 1860s and the early 1900s), such periods were
followed by lengthy weaknesses. In a 2001 paper, Sylla forecast a 10-year period of
deteriorating stock prices, ―When you have extraordinary returns, as we did from 1982
through 1999, then usually the next 10 years are not very good.‖ In short, Sylla believes
that exceptional booms steal gains from the future (IBF also believes in a variation of this
theme—reversion to the mean). Syllla feels that stocks will move up sometime during the
next two years.
During an ―average‖ year, corporate profits represent 5-6% of total economic output on
an after-tax basis. In 2006, that number was a record 9%. Since this number has
historically reverted to its mean, Sylla believes that profits will fall to 3-4% for a couple
of years.
S&P 500 VOLATILITY
According to a 2008 Crestmont Research paper, the S&P 500 moves about 15% over a
12-month period; in late 2006 and early 2007 the number dropped to just 3%. Another
way to measure historical volatility is to see the number of days the S&P 500 finishes
higher or lower by 1% or more; since 1950, this has happened roughly four days out of
every month. The average daily trading range has been 1.4% since the early 1960s.
U.S. STOCKS 2.5
QUARTERLY UPDATES
IBF | GRADUATE SERIES
As of early April 2008, the index experienced a five-month losing streak, a losing
record that the S&P 500 has only experienced six times in the past. Historically, after
such a losing streak, the S&P has gone on to post an 18% gain in the subsequent 12
months; in three of those six instances, returns exceeded 30%. The table below shows the
number of quarters per year the S&P 500 had a negative return from 1998 through the
first quarter of 2008.
S&P 500 Negative Quarterly Returns Per Year [4-2008]
Year - Quarters Year - Quarters Year - Quarters
1998 2 2002 2 2006 1
1999 1 2003 1 2007 1
2000 2 2004 1 2008 1st qtr. so far
STOCK MARKET DECLINES [1900-2008]
The table below shows the frequency of declines in the DJIA since 1990 through the first
quarter of 2008.
Dow Jones Industrial Average Declines [1990-2008]
Type of Decline Average Frequency Average Length Last Occurrence
Routine
(-5% or more)
3 times a year 47 days Nov. 2007
Moderate
(-10% or more)
Once a year 113 days Nov. 2007
Severe
(-15% or more)
Every 2 years 216 days Oct. 2002
Bear Market
(-20% or more)
Every 3.5 years 332 days Oct. 2002
S&P 500 RETURNS AFTER RECESSION LOWS
The table below shows the returns of the S&P 500 for 3-12 month periods after the index
has hit its recessionary low point. As you can see, from 1949 to 2008, the mean return has
ranged from 16% (3 months after the low point) to 32% (12 months after the index
reaches its low).
U.S. STOCKS 2.6
QUARTERLY UPDATES
IBF | GRADUATE SERIES
S&P 500 Returns After Lowest Point During A Recession
Low Date 3 Months Later 6 Months Later 12 Months Later
6-13-1949 14% 19% 34%
9-14-1953 10% 17% 38%
10-22-1957 6% 10% 31%
10-25-1960 16% 25% 31%
5-26-1970 17% 21% 44%
10-3-1974 13% 30% 35%
3-27-1980 18% 31% 37%
8-12-1982 38% 42% 58%
10-11-1990 7% 29% 29%
9-21-2001 18% 17% -14%
Mean 16% 24% 32%
S&P 500 DIVIDENDS
Board of directors do not increase dividends unless they feel positive about the
company’s future (one reason: they do not want to reduce the dividend in the future).
Since dividends cannot be manipulated, they do not present any accounting issues. For
the 2007 calendar year, 78% of the companies in the S&P 500 paid dividends, up from
76.6% in 2006. Overall, the number of S&P 500 companies that pay dividends has
steadily increased since 2001-2002, when it reached a low of 70%.
S&P 500 Dividend-Paying Companies
2006 2007
Dividend payers 383 390
Dividend increases 299 287
Initiation of dividend 7 11
Decrease in dividend 6 8
Suspension of dividend 3 6
U.S. STOCKS 2.7
QUARTERLY UPDATES
IBF | GRADUATE SERIES
U.S. STOCK RETURNS (2007)
2007 Dow Jones Investment Scoreboard
2006 2007
Stocks
Dow Jones Industrial Average 19.05% 8.88%
S&P 500 15.79% 5.49%
Russell 2000 18.37% -1.57%
Dow Jones Wilshire 5000 15.88% 5.62%
Bonds (Leman Brothers Indexes)
Long-Term Treasury Index 1.85% 9.81%
U.S. Credit Index AA-rated segment 4.32% 5.39%
Municipal Bond Index 4.84% 3.36%
Intermediate-Term Treasury Index 3.51% 8.83%
Mortgage-Backed Securities Index 5.22% 6.90%
Mutual Funds (Lipper Indexes)
Growth Fund Index 10.28% 8.45%
Growth and Income Fund Index 15.57% 4.68%
Balanced Fund Index 11.60% 6.76%
International Fund Index 25.89% 14.57%
Multi-Cap Value Index 17.07% -0.54%
Money Market (taxable) 4.28% 4.48%
Bank Instruments (Bankrate.com)
1-Year CD 3.70% 3.72%
30-Month CD 3.83% 3.71%
Money Market Deposit Account 0.80% 0.86%
Precious Metals (futures contracts)
Platinum 17.09% 34.15%
Gold 22.95% 31.35%
Silver 45.50% 15.35%
Residential Real Estate (repeat-sale index)
Office of Federal Housing Enterprise Oversight 4.2% 0.8%
QUARTERLY UPDATES
RETIREMENT
RETIREMENT 3.1
QUARTERLY UPDATES
IBF | GRADUATE SERIES
3.ROTH IRA VS. TRADITIONAL IRA
There are four variables used when comparing a traditional IRA with a Roth IRA: [1] tax
bracket during years of contribution, [2] retirement account’s assumed growth rate, [3]
number of years of compounding, and [4] tax bracket when withdrawals are made. The
obvious benefit of a traditional IRA is that contributions may be partially or fully
deductible; the big benefit of a Roth IRA is that withdrawals (if made) are tax free. The
table below shows all four of these variables.
Roth vs. Traditional IRA
Traditional
IRA
Roth
IRA
[1] Contributions at 25% tax rate $10,000 $7,500
[2] + [3] Value in 20 years $32,071 $24,054
[4] Tax rates go down in retirement (e.g., 15%) $27,260 $24,054
Tax rates go up (e.g., 28%) $23,091 $24,054
Tax rates stay at 25% $24,054 $24,054
5% ANNUAL WITHDRAWAL PORTFOLIOS
Older clients are concerned with how much of their account can be liquidated for current
income purposes, as well as the likely consequences. Based on an annual withdrawal
rate of 5%, increased by 3% after the first year (e.g., taking out $5,000 the first year
from a $100,000 account, $5,150 the second year, etc.), the table on the next page shows
the effects of such a withdrawal plan for 10 different portfolios. The figures are based on
data for the 38-year period ending December 31st, 2007.
Understanding the Table The fourth column (see next page), ―Worst 1-Yr. Drawdown,‖ factors in the portfolio’s
performance plus the annual withdrawal (5% per year, increased by 3% after the first
year). The fifth column, ―Loss Frequency,‖ shows how often, on an annual basis, the
portfolio experiences a loss if the annual withdrawals are also included. This column is
perhaps more ―real world‖ than the standard deviation column since few investors look at
a portfolio’s standard deviation—what they really focus on is the total value of the
portfolio from year-to-year.
RETIREMENT 3.2
QUARTERLY UPDATES
IBF | GRADUATE SERIES
One thing not fully appreciated is what happened to an all-cash portfolio versus one that
was half in cash and half in bonds. Volatility increased (from 3.1% to 3.6%) but the worst
one-year loss dropped from -13.9% to just -3.4%. Furthermore, the number of losing
years dropped from 53% of the time down to 24% of the time; the average loss in those
losing years also declined from -4.4% to -2.0%, over a 50% loss reduction. The sixth
column, ―Average Annual Loss,‖ shows the typical loss for those years in which there is
a loss—again, it factors in the 5% annual withdrawal.
Observations The all-cash portfolio has great appeal, particularly on a risk-adjusted return basis. The
problem is that once you factor in 5% annual withdrawals, it begins to lose much of its
luster. Moreover, if the impact of inflation and income taxes were also factored in (they
are not), the results would truly be dismal. At the other end of the spectrum, investing
100% in the S&P 500 (note: this portfolio is not shown above) sounds good since it
averaged 11.0% a year—until you look at its worst single-year performance, a loss of
over 26%. Many investors may not have the patience to wait and recover from such a
one-year drop. Equally important, the all-stock portfolio experienced quite a bit of
volatility from year-to-year (standard deviation of 16.6%); meaning that returns ranged
from -5.6% to +27.6% roughly two out of every three years (note: the ―other,‖ or third,
year saw returns that ranged from -22.2% to +44.2%).
RETIREMENT 3.3
QUARTERLY UPDATES
IBF | GRADUATE SERIES
Portfolio 38-Yr
IRR
38-Yr.
Std. Dev.
Worst 1-Yr.
Drawdown
Loss
Frequency
Average
Annual Loss
100% cash 7.0% 3.1% -13.9%
(2007)
53% -4.4%
1/2 cash
1/2 bonds
7.7% 3.6% -3.4%
(2004)
24% -2.0%
1/3 cash
1/3 bonds
1/3 large stocks
8.7% 6.4% -9.4%
(1974)
18% -4.3%
1/4 cash
1/4 bonds
1/4 large stocks
1/4 small stocks
9.5% 9.3% -14.2%
(1974)
24% -5.3%
1/5 cash
1/5 bonds
1/5 large stocks
1/5 small stocks
1/5 foreign stocks
9.9% 10.3% -16.9%
(1974)
21% -8.0%
1/6 cash
1/6 bonds
1/6 large stocks
1/6 small stocks
1/6 foreign stocks
1/6 equity REITs
10.2% 10.6% -18.8%
(1974)
16% -10.0%
1/7 cash
1/7 bonds
1/7 large stocks
1/7 small stocks
1/7 foreign stocks
1/7 equity REITs
1/7 commodities
11.2% 8.6% -10.2%
(1974)
21% -3.9%
20% cash; 40% bonds;
12% large stocks; 8%
small stocks; 10%
foreign stocks; 5%
REITs; 5%
commodities
9.6% 5.9% -7.3%
(1974)
16% -2.6%
40% large stocks
60% bonds
9.3% 8.0% -12.2%
(1974)
21% -4.7%
60% large stocks
40% bonds
9.7% 10.7% -18.8%
(1974)
26% -6.6%
RETIREMENT 3.4
QUARTERLY UPDATES
IBF | GRADUATE SERIES
Risk-Return Tradeoffs (the efficient frontier) The highest returning portfolio for the 1970-2007 period was the one that was
comprised of seven equal parts (cash, bonds, large stocks, small stocks, foreign
stocks, REITs and commodities), it averaged over 11% a year with an 8.6%
standard deviation. This seven-part portfolio had better returns and less risk than any
portfolio whose returns averaged 9.5% or higher—except the seven-part portfolio that
was not equally weighted (20% cash, 40% bonds, 12% large stocks, 8% small stocks,
10% foreign stocks, 5% REITs and 5% commodities).
For clients whose priority is to experience the fewest losing years after factoring in a 5%
annual withdrawal, the two best portfolios were 100% cash and the unequally weighted
seven-part portfolio described above. Between the two, the seven-part portfolio would
have been a much better choice for the investor concerned with the effects of inflation
and/or income taxes.
The Portfolios o Cash = 3-month U.S. Treasuries
o Bonds = Lehman Brothers Intermediate-Term Bond Index
o Large Stocks = S&P 500
o Small Stocks = Ibbotson Small Stocks (1970-1978) Russell 2000 Index (1979-
2007)
o Foreign Stocks = EAFE Index
o Equity REITs = NAREIT Equity Index
o Commodities = S&P GSCI Commodity Index
The Advisor’s Decision As the advisor, your job is to point out: (1) historical returns range wildly and no one
knows what the future will hold except that there will be many surprises, (2) the
cumulative effects of inflation are meaningful and rarely reflected in any performance
tables, (3) the more conservative investments are usually fully taxable (e.g., cash and
bonds), (4) if in doubt, diversify into a number of categories (e.g., a seven-asset or more
portfolio), and (5) if the client does not understand each asset category and is easily
overwhelmed, consider a basic conservative (60% bonds and 40% large stocks) or
somewhat moderate (60% large stocks and 40% bonds) portfolio—if there is any doubt,
emphasize the bond weighting (also consider using a fixed-rate annuity for part of the
bond portion).
QUARTERLY UPDATES
ANNUITIES
ANNUITIES 4.1
QUARTERLY UPDATES
IBF | GRADUATE SERIES
4.EXTREMELY LOW COST VARIABLE ANNUITY
Jefferson National Life’s Monument Advisor charges no upfront commissions and no
surrender charges but provides no death benefit. Monument Advisor contract owners pay
just $20 a month in fees (and no other M & E expenses), whether the investment is worth
$5,000 or $1,000,000.
SUBSTANDARD ANNUITIZATION
Advisors generally consider annuitization for conservative clients in good health trying to
maximize their current income. However, a number of insurers (see table below) offer
substandard annuitization, designed to increase payments for those who do not have
great health. Unlike traditional annuities, substandard annuities require underwriting.
The agent gathers medical information from the client and submits it to one or more
substandard carriers.
After processing the information, the insurance carrier will provide an ―age rating‖ (e.g.,
someone age 67 may get an age rating of 70 or higher if their health is below average for
their age). Some companies will also provide an annuitization quote, other carriers will
allow the agent to run his or her own quotes based on the ―revised‖ age. For example, a
67 year old may have the health of a 70 year old, thereby qualifying for 14% monthly
payment increase (see table below).
Insurers Offering Substandard Annuities
AIG American General Protective Life Jefferson-Pilot Life
Fidelity & Guaranty Life Aviva Life Presidential Life
Golden Rule Insurance Genworth Financial United of Omaha Life
Lincoln Benefit Life
ANNUITIES 4.2
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Monthly Income for $100,000 Substandard Annuity
Male, age 60
Rated
Age
Monthly
Income
Increase Over
Standard Annuity Rated
Age
Monthly
Income
Increase Over
Standard Annuity
65 $680 0% 71 $796 17.0%
66 $697 2.4% 72 $821 20.7%
67 $714 5.0% 73 $847 24.6%
68 $733 7.8% 74 $876 28.8%
69 $753 10.7% 75 $906 33.2%
70 $774 13.9%
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GLOBAL INVESTING
GLOBAL INVESTING 5.1
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5.GLOBAL ECONOMICS
During 2007, the developing countries produced over 52% of global growth, compared to
37% during the late 1990s; China alone produced 18% of global GDP, compared to 15%
for the United States. Developing countries now represent 29% of the total world’s
output, compared to 18% in 1995. For 2008, the World Bank forecasts that the economies
of developing countries will grow over 7%, compared to 3% in older industrialized
nations.
As of the beginning of 2008, the capitalization of the U.S. stock market was $17.5
trillion, versus $17.8 trillion for all of the developing countries (which was just $2.2
trillion in 2000). In 2000, consumer spending for the 17 largest emerging economies was
equal to 48% of U.S. consumer spending; in 2007 that number increased to 65%. The
United States’ share of global imports fell from over 20% in 2000 to 14% in 2007. The
import share of the developing countries has grown from 33% in 2000 to 41% in 2007.
COUNTRIES HOLDING U.S. DEBT
As of June 2007, the major foreign holders of U.S. Treasury securities were: Japan
($612b), China ($405b), U.K. ($190b), oil exporting countries ($122b), and Caribbean
banking centers ($49b).
FRONTIER INDEX
The Merrill Lynch Frontier Index tracks 50 of the largest and most highly-traded stocks
in 17 countries, from Kuwait to Kazakhstan; stocks that are so much off the radar
screen, they do not qualify for ―emerging markets‖ status. Roughly half of the index is
comprised of Middle Eastern stocks. The market value of the 50 stocks in the index is
$366 (about the same market capitalization as GE). Other markets represented in the
index are Nigeria, Cyprus, Vietnam and Pakistan.
The two biggest appeals of frontier stocks (and funds) is that the data, so far, shows that
correlations to other markets is random and that returns can be quite attractive (e.g., from
the beginning of 2007 through February of 2008, the Merrill index was up 70%). Another
short-term appeal is the fact that a number of Persian Gulf countries went through a
bubble period that ended in large stock market price drops during 2006.
GLOBAL INVESTING 5.2
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GLOBAL STOCK RETURNS
2007 Dow Jones Global Index Returns
Country
U.S.
Dollars
Local
Currency
Country
U.S.
Dollars
Local
Currency
Brazil 71.1% 42.6% Greece 29.8% 17.1%
Malaysia 44.6% 35.5% Singapore 27.6% 19.7%
Hong Kong 44.5% 44.9% Canada 27.1% 7.8%
Thailand 39.0% 29.5% Norway 26.8% 10.6%
Indonesia 39% 45.1% Australia 25.3% 12.4%
Finland 39.0% 25.3% Portugal 24.5% 12.3%
Philippines 36.7% 15.1% Chile 23.0% 15.1%
South Korea 33.6% 34.5% Spain 17.8% 6.2%
Germany 30.5% 17.7% Denmark 17.6% 6.1%
Country
U.S.
Dollars
Local
Currency
Country
U.S.
Dollars
Local
Currency
Iceland 13.1% -0.2% U.S. 3.8% 3.8%
South Africa 12.6% 9.1% New Zealand 2.2% -6.4%
Netherlands 12.0% 1.0% Italy 1.7% -8.3%
France 11.3% 0.4% Austria 1.6% -8.4%
Mexico 10.8% 11.7% Sweden -3.1% -8.5%
Taiwan 6.5% 6.0% Japan -6.0% -11.9%
Belgium 5.6% -4.7% Ireland -19.2% -27.1%
Switzerland 5.6% -2.0% World 8.4%
U.K. 3.8% 2.1% World, ex. U.S. 11.8%
For the 2007 calendar year, India’s stock market, as measured by the Bombay Sensex
Index, was up 39.3% in local currency. China’s Shenzhen A Shares were up 167.0% and
their Shanghai A Shares were up 96.1%, both in local currency terms.
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FINANCIAL PLANNING
FINANCIAL PLANNING 6.1
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6.BRIEF HISTORY OF RATING AGENCIES
Since 1975, the SEC has limited competition in the market for credit ratings by
appointing a very limited number of companies as ―Nationally Recognized Statistical
Rating Organizations (NRSROs). Starting in 1992, the SEC went an entire decade
without allowing a single new competitor into the market. Thomson reports that in 2007,
Moody’s rated 95% of corporate bonds, while S&P rated 93%. Fitch, at 37%, is the only
other firm with significant market share. S&P rates 96% and Moody’s rates 86%of
mortgage-backed and asset-backed issues, which represent pools of auto loans, credit
card receivables and the like; Fitch rates 58%.
CLOSED-END FUND 2008 DISCOUNTS
As of the middle of January 2008, closed-end funds (CEFs) were trading at an average
discount to NAV of just under 7% (reaching almost an 11% discount in November 2007).
Over the past 10 years (ending 12-31-2007), shares usually sold for 4% below NAV,
according to Wachovia Securities. The larger than normal gap represents investor
concerns over the credit markets and, to a lesser degree, tax-related trading.
During January of 2007, a record for the largest CEF was set by Alpine Total Dynamic
Dividend Fund, when it raised $3.5 billion; a month later, Eaton Vance raised $5.5 billion
for its Tax-Managed Global Diversified Equity Income Fund. Less than a year later, the
Eaton Vance investors had experienced a cumulative loss of over 8%, even though the
fund’s assets had appreciated over 7%. Of the seven $1+ billion CEFs that hit the market
in 2007, all but one are trading at discounts of more than 5%. It appears that the
marketplace has viewed all of these CEFs the same, regardless of their portfolio
composition.
HOW CREDIT SCORES ARE DETERMINED
Credit scores are based on five criteria (weightings shown in parentheses): payment
history (35%), amount you owe (30%), length of credit history (15%), types of credit you
are using (10%) and new credit (10%). Your clients can improve their credit scores by
following these steps:
Step 1: Order a credit report from all three major credit-reporting bureaus at
www.annualcreditreport.com. By law, a person is entitled to one free credit report a year
from each of the reporting agencies: Equifax, Trans-Union and Experian.
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Step 2: Once your client receives the credit reports, they should be reviewed for
mistakes. Credit bureaus are required to investigate disputed items, usually within 30
days.
Step 3: Buy your FICO credit score from Equifax for $8; you can order your credit score
from Fair Issac’s website (www.myfico.com), prices range from $16 for a FICO score to
$48 for all three credit scores and reports (note: there may be variations among the three
reporting agencies because some lenders do not report to all three credit bureaus). The
free credit report your client is entitled to (Step 1) does not include a credit score.
Step 4: Since payment history represents 35% of the overall FICO credit score, it is
important that bills are paid on time. A late payment can stay on a report for up to seven
years. On a positive note, lenders pay more attention to recent history than to any past
misdeeds.
Step 5: Encourage your client to reduce any outstanding debt (30% of the overall score).
For example, if someone has a $5,000 credit limit and a current balance of $2,500, their
―credit utilization‖ is 50%. A credit score reflects the debt ratio for each credit card.
Step 6: Avoid or minimize new credit accounts. Every time a new credit card or line of
credit is sought, the lender will request a credit report. Lenders believe that someone
seeking additional credit is more likely to fall behind on payments. Furthermore, the
addition of a new line of credit means that the average age of all credit accounts
combined drops, which could also hurt the credit score (length of credit history is 15% of
the overall score).
GIFTS AND QUALIFYING FOR MEDICAID
Individuals generally become eligible for Medicaid after using up all but about $2,000.
Some people try to get around the intent of the law by making cash gifts to their children.
However, Medicaid has a five-year look-back period, potentially penalizing an applicant
or Medicaid recipient for any gifts made up to five years ago (note: the previous look-
back period was three years).
FINANCIAL PLANNING 6.3
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Besides increasing the look-back period, Medicaid has also changed the penalty period.
In the past, the penalty period was calculated based on when the gift was made; the clock
now starts when someone applies for Medicare. For example, suppose that under the old
rules, a New York City resident gave away $27,000 a year before applying for Medicaid
(note: $27,000 represents the cost of three months of long-term in NYC). In such an
instance, there would be no negative consequences for the applicant because an
application was not made for 12 months (nine months longer than the potential three
month penalty period). Under the new rules, there would definitely be consequences—
there would be no Medicaid payments for the first three months of the nursing home stay.
Your clients can find out the probability of needing nursing home care based on their age
and gender as well as the average length of stay by contacting the New England Journal
of Medicine which periodically collects such data from the National Nursing Home
Survey (NNHS).
SOCIAL SECURITY SPOUSAL BENEFITS
When you begin receiving Social Security retirement benefits, your spouse may also
qualify to receive a check based on your earnings. You cannot receive spousal benefits
until your spouse has claimed Social Security. However, once you reach age 62, you can
always apply for benefits based on your own earnings.
When a spouse files for a reduced benefit based on his or her earnings, Social Security
checks to see if the applicant is also eligible for a spousal benefit. If so, that spouse is
deemed to have filed for both her benefit (as a worker) and the spousal benefit. In such a
situation, the filing spouse will usually receive the higher of the two amounts. As a side
note, you cannot claim spousal benefits at age 62 based on the other spouse’s earnings
and then claim benefits at full retirement age based on the applicant’s earnings (assuming
the other spouse is already collecting benefits).
If a 62-year-old working spouse claims reduced benefits based on his or her earnings, he
or she can ―step up‖ to a spousal benefit when that spouse retires (this assumes that the
other spouse, not yet retired, has higher earnings than the 62-year-old spouse). However,
often it is best to wait until ―full retirement age‖ (age 65-67, depending upon your year of
birth). For example, suppose Mr. Smith is expected to receive $1,800 a month from
Social Security at his full retirement age. Based on her earnings, Mrs. Smith is scheduled
to receive $800 a month at her full retirement age. If Mrs. Smith does wait until this time,
and assuming that Mr. Smith has also waited and is receiving benefits, she will then
receive $900 a month (the higher of her full benefit or ½ the benefit of Mr. Smith).
FINANCIAL PLANNING 6.4
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DEFINING A RECESSION
The academic group, The National Bureau of Economic Research, is responsible for
formally determining when a U.S. recession begins and ends, but waits until the data
cannot be disputed, typically several months after the recession actually began. For
example, in March 2001, eight months after the fact, the bureau announced the U.S. was
in a recession. The irony was that it was later determined that when the announcement
was made, the recession was already over.
OIL O’PLENTY
Although estimates vary, it is generally agreed that there are approximately 6-8 trillion
barrels for conventional oil reserves and another 6-8 trillion for unconventional oil
resources (e.g., shale oil, tar sands, extra heavy oil, etc.). As a point of comparison, the
world has consumed a total of one of those 12-16 trillion barrels since it began using oil.
Currently, the oil industry is able to recover an average of just one of three barrels from
conventional resources and much less for unconventional. If there were just a 10% future
increase in production, the increase would translate into another 50 years of supply at
current consumption rates. Current world oil consumption is about 86 million barrels per
day, with projected annual increases of 0-2%.
HEALTH CARE COSTS
Health care costs account for 1/6th
of the economy, compared to 1/10th
in the early
1980s. In 2005, the U.S. spent $2 trillion on health care, the equivalent of $6,700 per
person. About 16% of U.S. citizens are uninsured; Hawaii has required employers to
provide medical insurance for employees since 1974. Young adults are the most likely
group to be uninsured; ages 18 and 34 account for 25% of the population but 41% of
those without insurance.
A 2008 report by the Center for Retirement Research at Boston College estimates that
even before health care costs are factored in, 44% of working age households are at risk
of being unable to maintain their standard of living in retirement. Add in health expenses,
and the figure rises to 61%. The table below shows the amount of a single-premium
fixed-rate annuity needed at retirement to cover projected out-of-pocket health care costs
for people retiring at age 65, in 2007 dollars.
FINANCIAL PLANNING 6.5
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Investment Needed To Fund Health Care Costs
Retirement Year Single Couple
2010 $103k $206k
2020 $142k $284k
2030 $189k $378k
2040 $246k $492k
RECESSION AND OTHER CONCERNS
As of April 2008, by a 3–to-1 margin, economists surveyed by The Wall Street Journal
believe the U.S. is in a recession. When asked what the biggest downside risk was, 35%
said further deterioration in the credit markets, 25% believed it would be a further drop in
consumer spending and 13% felt it would be continued housing weakness.
The consensus view among the economists was that the unemployment rate would
increase from 5.1% to 5.6% by December. Just 21% of the economists surveyed expect
home prices to bottom in 2008; 67% expect the bottom to be in 2009 while 12% believe
it will not happen until 2010.
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REAL ESTATE
FINANCIAL PLANNING 7.1
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7.HOME OWNERSHIP AS AN INVESTMENT
Advisors know that not even a stock market trader would put 60% or 70% of their
portfolio in just one stock. Yet, tens of millions of people have that much or more of
their total net worth in just one house. Over the past 30 years (1977 to 2007), home
prices, on average, increased 481%; San Francisco home owners enjoyed an 1,125%
increase, while residents of Houston experienced just 200% appreciation (source: Office
of Federal Housing Enterprise Oversight).
If you bought a house in Los Angeles in 1990, just as that real estate marketplace turned
downward, you would have had to wait 10 years before the home’s value returned to
what you paid for it. If you bought in Rochester, N.Y. in 1980, your annual appreciation
rate for the next 25 years was 4% (between 0-1% if you adjust for inflation). If you
bought in Dallas in 1986, as the oil boom went bust, your home would not have
appreciated at all before 1998.
To put things in perspective, if you bought a $50,000 home in San Francisco in 1977, it
was worth $613,000 by the beginning of 2007 (1,125% appreciation); after ownership
expenses (e.g., mortgage interest, taxes, insurance, maintenance and major repairs), the
true profit would have been $219,000. The comparable house in Los Angeles would have
been worth $593,000 in Los Angeles (1,085%), $549,000 in New York (998%) and
$432,000 in Washington (763%)—all of these figures are before ownership costs are
subtracted. In some large cities, homeowners did not fare as well during the 1977 to 2007
period. In Chicago, a $50,000 home grew to $282,000 (463%), $176,000 in Dallas
(252%) and just $147,000 in Houston (193%). After deducting ownership expenses in
these three cites, homeowners would have actually lost money over this 30-year period
(not to mention the effects of inflation along with the tax ramifications upon sale).
MORTGAGE IMPACT REDUCTION
By adding an additional $300 per month to the payment on a 6.25%, 30-year, $300,000
loan, the borrower will end up saving 10 years of payments and $83,000 of after-tax
money. Adding just a $100 a month (instead of $300) results in a savings of $57,000 of
interest payments and shaves four years off a 30-year mortgage. Change the $100 to $500
per month one saves $170,000 and reduces the length of the mortgage from 30 to 17
years.
FINANCIAL PLANNING 7.2
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REVERSE MORTGAGE CALCULATOR
One way to figure out how much your client can net out from a reverse mortgage is to go
to the web site goldengateway.com (and click on ―Do the Math‖). By plugging in the
client’s zip code, age and value of the home, the site shows the different lump sums and
monthly payouts available from different lenders. A separate chart shows the closing
costs and related fees (which are typically quite high).
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BONDS
BONDS 8.1
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8.MUNICIPAL BOND INSURANCE
Roughly half of the $2.6 trillion municipal bond market is insured by firms such as
MBIA, Ambac Financial Group and Financial Guarantee Insurance. If there is a
default, the insurer guarantees repayment. Fortunately, few municipal bonds ever default.
For example, municipal bonds with a BB rating have a cumulative average 10-year
default rate of 1.74% since 1970 (meaning an average of just 0.74% per year); BB
rated corporate bonds have a 29.93% 10-year cumulative default rate (meaning an
average of 2.99% per year), according to Municipal Market Advisors.
The security of municipal bonds becomes much greater when looking at BBB rated
bonds by S&P, a mere 0.32% cumulative average over 10 years (or 0.03% per year),
versus 0.6% cumulative 10-year average for AAA rated corporate bonds (or 0.06% per
year).
Before the 2007-2008 bond-insurer crisis, bond insurers charged about 30% of the
interest-rate savings an issuer would get; during the early parts of 2008, that figure rose to
80-90%. In some cases, the need for bond insurance seems weak; the state of California
takes in over $100 billion of revenue each year (posing the question, ―Would you rather
be exposed to the state of California for 30 years or the credit of a bond insurer for the
next 30 years?‖).
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THE ECONOMY
THE ECONOMY 9.1
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9.U.S. RECEIPTS AND DISPERSEMENTS
For fiscal year 2009, total receipts collected by the U.S. Government are expected to be
$2.7 trillion. The largest source, $1.26 trillion, will come from individual income taxes,
followed by $949 from Social Security and Medicare payroll taxes, $339 from corporate
income taxes and $152 billion from excise and other taxes.
The proposed $3.1 trillion outlays for fiscal year 2009 are: $992 billion paid to Medicare,
Medicaid and similar beneficiaries, $644 billion paid to Social Security recipients, $671
billion to defense, $541 billion to non-defense spending and $260 billion of net interest
payments.
U.S. CREDIT CRUNCH AND BANKS
As of the beginning of 2008, losses from the credit crunch represented 0.7% of U.S.
GDP, versus 3.2% during the savings and loan collapse in the late 1980s. Bank
deregulation in the 1970s and 1980s spurred the creation of larger banks and greater
competition. Between 1975 and 2005, the number of banks declined from 13,500 to
7,500, but the number of bank locations nearly doubled to 80,300. Since 1934, there
have only been two years when no U.S. banks failed: 2005 and 2006, according to
FDIC. During the S&L crisis of 1988-89, U.S. banks failed at a rate of more than two
every business day. According to FDIC, real estate holdings accounted for 58% of
total assets for U.S. banks in 2006.