Copyright © 2009 by Institute of Business & Finance. All rights reserved. v1.1

QUARTERLY UPDATES

Q4 2008

Quarterly Updates

Table of Contents

BONDS

BOND YIELDS 1.1

BONDS INSTEAD OF STOCKS? 1.1

2008 CORPORATE BOND DECLINES 1.1

2009 HIGH-YIELD BOND DEFAULT RATES 1.2

MUTUAL FUNDS

60% MUTUAL FUND CLUB 2.1

CLOSED-END FUNDS 2.1

MONEY MARKET FACTS 2.2

FRONTIER FUNDS 2.2

YEAR-END WINDOW DRESSING 2.3

MUTUAL FUND RETENTION RATES 2.4

MANAGER OF THE YEAR AWARDS 2.5

ETFS AND ETNS

2008 ETF AND ETN WINNERS AND LOSERS 3.1

ETNS 3.1

FINANCIAL PLANNING

JOINT TENANCY BASIS ADJUSTMENT 4.1

FINANCIAL PLANNING SURVEY 4.1

THE FUTURE OF HOME PRICES 4.2

CLIENTS BECOMING MORE REALISTIC 4.2

HOW THE EXPERTS ALLOCATE 4.3

NO REQUIRED 2009 IRA WITHDRAWAL 4.3

PROTECTING RETIREES FROM THEMSELVES 4.4

WHEN THE ORDER OF GAINS AND LOSSES MATTER 4.4

ECONOMICS

RECESSION MEASUREMENT 5.1

2008 BANK FAILURES 5.1

STOCKS

BULL AND BEAR MARKET CYCLES 6.1

LARGEST DOW PERCENTAGE GAINS 6.2

COMMODITY VS. STOCK PRICES 6.2

2009 PROJECTED EARNINGS FOR THE S&P 500 6.3

ANNUITIES

INTERESTING ANNUITY FACTS 7.1

EIAS BECOMING SECURITIES 7.2

MISCELLANEOUS

MONEY MARKET FACTS 8.1

2008 REIT RETURNS 8.1

HEDGE FUND LEVERAGING 8.2

ALTERNATIVE ASSETS 8.2

CONVERTIBLES 8.2

TAXES

2009 TAX CHANGES 9.1

AVOIDING AN IRS AUDIT 9.2

SOCIAL SECURITY

ONLINE SOCIAL SECURITY APPLICATIONS 10.1

2009 SOCIAL SECURITY INCREASE 10.1

SOCIAL SECURITY FOR MARRIED COUPLES 10.1

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BONDS

BONDS 1.1

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1.BOND YIELDS

At the beginning of 2009, investment-grade bonds yielded 5.25 percentage points more

than Treasuries, while junk gave about 15-18 percentage points more. At the beginning of

2008, those differences were 2 percentage points and 5.76 percentage points, respectively

(source: S&P). According to the Merrill Lynch Master II High Yield Index, the gap

between Treasuries and high-yield bonds hit a peak of 21.82 percentage points in

mid-December 2008. For the 2008 calendar year, high-yield bonds as a broad category

were down by about a third.

BONDS INSTEAD OF STOCKS?

According to some analysts, bonds may be a better way to invest starting in 2009. These

bond advocates point out an investor can get 8-10% a year in high-quality corporate

bonds that historically have had one third the volatility of stocks. The attraction to fixed

income is also due to the belief that the market has already priced in future risk. The

spread between quality corporates and Treasuries is the widest seen in 75 years. The

default rate for investment-grade corporate bonds is expected to increase from 0.3% to

about 1.0% per year; the market is pricing in a 5% default rate. In the past, stocks have

bottomed at about seven times earnings (versus a 10.5 times earnings ratio as of the end

of 2008).

2008 CORPORATE BOND DECLINES

While several broad stock market indexes were down 37-40% or more in 2008, a number

of mortgage and corporate bonds lost 30-80% of their value. Commercial AAA-rated

bonds were trading at 60 cents on the dollar during November 2008, yielding over 15

percentage points more than Treasuries. Corporate leveraged loans, many of which are

fully secured by company assets such as buildings, machinery and receivables were

trading for 65 cents on the dollar during the same period. Normally such corporate bonds

trade at 100 cents on the dollar. All of these bonds had sharp sell-offs during the last few

months of 2008 because banks and hedge funds that had used borrowed money were

forced to liquidate parts of their holdings.

BONDS 1.2

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2009 HIGH-YIELD BOND DEFAULT RATES

A January 2009 survey by The Wall Street Journal indicates that by the end of 2009, 9%

of junk-rated debt will default. S&P expects a record-setting 14% for the year, while

Moody’s is projecting a 15% default rate (vs. 4% for 2008) by year-end of 2009. Just a

month earlier, Moody’s had predicted a 10.4% default rate for 2009.

In 1997, the cumulative size of the high-yield debt market was $350 billion. By the

beginning of 2007 it exceeded $1 trillion (in part due to the lowering of the ratings for

Ford and GM bonds). The financial panic during September and October of 2008 saw

junk bonds experience their two worst months ever, down -8.4% and -17.8% respectively

(source: Citigroup High-Yield Composite Index).

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MUTUAL FUNDS

MUTUAL FUNDS 2.1

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2.60% MUTUAL FUND CLUB

The following three mutual funds were down more than 60% for 2008:

-65% Legg Mason Opportunity Trust (LMOPX)

-61% Winslow Green Growth (WGGFX)

-60% Legg Mason Growth Trust (LMGTX)

The losses of these three funds represent a lag of roughly 20 percentage points behind

their broader category—domestic stock funds were down an average of 38% in 2008. In

contrast, an ounce of gold peaked at an all-time record of $1,003.20 on March 18th

, 2008.

CLOSED-END FUNDS

A number of CEFs “juice” dividends by leverage, using borrowed money. During severe

market declines such as 2008, these funds had fewer assets for collateral. This put them at

risk of missing a regulatory cutoff beneath which they are barred from making payouts to

shareholders. As of early January 2009, more than 150 of 525 CEFs that pay monthly or

quarterly dividends had cut payouts. About 50 more such funds still yield more than 25%

(source: Herzfeld).

Under the Investment Company Act of 1940, closed-end funds must maintain asset

coverage of at least 200% with respect to senior securities such as action-rate

preferred securities. For each $1 of preferred stock issued, a fund must have at least $2

in assets. A fund is prohibited from declaring or paying a dividend that would put it

below the 200% asset-coverage ratio.

As of the beginning of 2009, there were approximately 630 stock and bond CEFs with an

estimated $180 billion in assets, down from $300 billion at the end of 2007. Most closed-

end funds trade at a discount. The average CEF discount hit a record level discount of

26% on October 15th

, 2008. Only two new CEFs came to market during 2008 (source:

Herzfeld).

MUTUAL FUNDS 2.2

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MONEY MARKET FACTS

Reserve Management Company offered the first money market fund in the early 1970s.

These New York money market funds “broke the buck” in September 2008. The Reserve

fund owned $785 million of Lehman debt when the investment bank filed for bankruptcy

on September 5th

, 2008. The fund wrote down the debt to zero, thereby reducing its NAV

to 97 cents a share.

Prior to this, there had been just one occasion when a fund broke the buck. This earlier

instance occurred in 1994 when a small fund, Community Bankers U.S. Government

Money Market Fund sustained losses in financial derivatives; the fund was geared

towards institutions so no small investor lost money.

Before Reserve Management incurred the September 2008 problem, there had been at

least 20 other instances wherein fund companies (e.g., Bank of America, Northern Trust

and Wells Fargo) also incurred money market losses. However, in all such instances, the

fund company stepped in and made the fund whole.

The average annual expense ratio of a money market fund is 0.58% according to

Morningstar. Money market funds as a whole: [a] hold about 20% of all municipal debt

outstanding, [b] hold about 20% of all marketable Treasury bills and [c] hold more than

40% of outstanding U.S. corporate commercial paper.

FRONTIER FUNDS

According to a number of market observers, “emerging markets have been picked over in

terms of interesting ideas; investors looking for significantly mispriced and undervalued

opportunities need to look farther afield.” Such frontier markets, so-called because they

sit at the edges of the investment world, have outperformed the S&P 500, the MSCI

Emerging Markets Index and other benchmarks over the past 10 years. Examples of

frontier funds include: T. Rowe Price Africa & Middle East Fund, Claymore/BNY

Mellon Frontier Markets, Morgan Stanley Frontier Emerging Markets Fund, Market

Vectors Africa, PowerShares MENA Frontier Countries and Lazard Emerging Markets

Equity Fund.

MUTUAL FUNDS 2.3

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Countries on the investment frontier can be thought of as “emerging emerging

markets”—just beginning to get their economies in order. China 20 years ago would have

been a frontier fund, Brazil or Poland 10-15 years ago. Today’s frontiers are places like

Pakistan, Jamaica, Trinidad, Tobago, Bulgaria, Ukraine, Nigeria (e.g., 150 million people

and just 10 million bank accounts), Bangladesh (e.g., poised to take the contract drug-

manufacturing business from India) and Vietnam (replacing manufacturing plants in

China).

YEAR-END WINDOW DRESSING

Portfolio managers have been doing year-end window dressing since the 1929 crash. A

fund that engages in window dressing hopes to “present a financial statement of sound

appearance” for their reporting period. Reading a December report alongside the same

year’s June report will help ensure the advisor is not getting a naively rosy view.

Sometimes referred to as “banging the close,” one year-end window dressing tactic is for

a small or micro cap fund manager to run up the price of what the fund already owns.

There are examples of small cap stocks that increase by 33% the day before the end of

the trading year and then drop by 10-20% or more by January 2nd

or 3rd

of the next year.

In some cases, the run up is even more suspect when one discovers that the stock in

question was down 80% for the calendar year (despite the bump up in last-day trading).

Historically, 80% of all U.S. stock funds and 91% of small cap funds have beaten the

market on the last trading day of the year. Roughly two-thirds of these funds end up

giving back most of that gain on the first day of the following year.

On a somewhat related note, a study by finance scholar Berk Sensoy shows 31% of U.S.

stock funds pick a benchmark that does not closely reflect what they own—making it

easier for management to beat “the market” (and receive a bigger bonus).

MUTUAL FUNDS 2.4

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MUTUAL FUND RETENTION RATES

Manager departures are often a leading indicator of trouble within a mutual fund family.

Parent companies have explanations for such departures, but managers generally do not

leave if they have the support and analysis they need and they are paid at least relatively

well. The table below shows mutual fund company manager retention rates.

Mutual Fund Company Manager Retention Rates [2003-2007]

Fund Family Retention Fund Family Retention

American Funds 97% Hartford Mutual Funds 91%

Dodge & Cox 97% ING Retirement Funds 86%

Vanguard 92% Van Kampen 88%

T. Rowe Price 95% Fidelity Investments 86%

PIMCO 89% MFS 84%

Oppenheimer 92% Principal Funds 85%

Alliance Bernstein 90% John Hancock 85%

Franklin Templeton 92% JP Morgan 82%

GMO 90% Columbia 86%

American Century 91% Black Rock 85%

Janus 92% DWS Investments 82%

Invesco Aim 86% Putnam 79%

MUTUAL FUNDS 2.5

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MANAGER OF THE YEAR AWARDS

Listed below are Morningstar’s 2008 managers of the year. The picks are based on “long-

term performance and strong stewardship.”

Domestic Stock

Charlie Dreifus of Royce Special Equity (RUSEX)

runner-up: Bob Goldfarb and David Poppe of Sequoia Fund (SEQUX)

Fixed-Income

Bob Rodriguez and Thomas Atteberry of FPA New Income (FPNIX)

runner-up: Bill Gross—Harbor Bond (HABDX) and PIMCO Total Return (PTTRX)

International Stock

David Samra and Dan O’Keefe of Artisan International Value (ARTKX)

runner-up: Jean-Marie Eveillard of First Eagle Overseas (SGOVX)

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ETFS AND ETNS

ETFS AND ETNS 3.1

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3.2008 ETF AND ETN WINNERS AND LOSERS

At the beginning of 2009, there were about 730 U.S. listed ETFs with $450 billion in

total assets and about $100 billion in daily trading volume (source: Morgan Stanley).

Listed below are some of the biggest gainers and largest losers; the S&P 500 lost 37% in

2008.

+ 61% ProShares UltraShort S&P 500

+ 55% Vanguard Extended Duration Treasury ETF (20-30 year zero-coupon)

+ 34% iShares Lehman 20+ Year Treasury Bond Fund

+ 24% SPDR Lehman Long-Term Treasury

- 41% iShares MSCI EAFE Index Fund

- 43% iShares Dow Jones U.S. Home Construction

- 45% PowerShares FTSE RAFI Emerging Markets

- 56% U.S. Oil Fund

- 85% PowerShares Ultra Financial

ETNS

Due to the financial meltdown in the second half of 2008, investors pulled out close to

$500 million from 90 exchange-traded notes (ETNs), representing close to 10% of the

ETN industry’s overall assets of $5.5 billion (source: Morningstar). The largest ETN,

iPath Dow Jones-AIG Commodity Index Total Return, run by Barclays, has $2.7 billion

and saw 12% of its outstanding shares redeemed. ETNs were invented by Barclays in

2006 to complement iShares ETFs. Other companies that offer ETNs include: Deutsche

Bank, J.P. Morgan, Goldman Sachs and UBS.

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FINANCIAL PLANNING

FINANCIAL PLANNING 4.1

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4.JOINT TENANCY BASIS ADJUSTMENT

For married investors who do not live in a community property state, if a stock is

transferred from one spouse to another spouse and death of the donor occurs within a

year of the new ownership, there is no basis adjustment. Normally, death of a joint owner

means that the survivor receives a step-up in basis on the donor’s half interest as of the

date of death.

FINANCIAL PLANNING SURVEY

According to a 2008 survey of households with $250,000+ of investments, the top five

financial issues and decisions were (source: Wall Street Journal survey): [1] maintaining

lifestyle, [2] increasing current asset level, [3] maintaining current asset level, [4]

affording healthcare for family and [5] managing investment risk. All five of these issues

were of similar importance.

The same survey asked, “what were the top three reasons why a financial planner or

advisor was used,” and close to two-thirds of the respondents said that they either wanted

to make sure their money would last through retirement or because their perception was

the professional would do a better job than they would. A third of respondents said they

were using a planner or advisor to rollover a retirement plan. The next table, based on the

same survey from the WSJ, asked respondents to rank the top five items most important

to them when looking for qualities in a planner or advisor.

Important Qualities in a Financial Advisor

Trait Very

Important

Works in my best interest 94%

Understands financial situations and goals 86%

Is available and responsive 69%

Willing to listen and discuss ideas 67%

Provides periodic measurement of plan against

goals

63%

FINANCIAL PLANNING 4.2

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THE FUTURE OF HOME PRICES

Karl Case, an economics professor at Wellesley College whose name adorns the S&P

Case-Shiller home-price indexes, has studied house prices going back to the 1890s.

According to Case, over the long run, home prices tend to increase at an inflation-

adjusted rate of 2.5% to 3% a year. William Wheaton, a real estate and economics

professor at MIT, expects housing prices to increase at an annual rate of 1% above

inflation. Moody’s Economy.com, a research firm, expects housing prices to increase at

an average rate of 4% a year over the next couple of decades.

In the long term, house prices are driven by fundamentals that are hard to predict:

immigration, birth rates, the size and nature of households and incomes. From the

beginning of 1990 to the end of 2008, the average U.S. home price is up about 35%

adjusted for inflation.

CLIENTS BECOMING MORE REALISTIC

Many of the 80 million baby boomers between the ages of 44 and 63 no longer expect

their advisor to try and trounce the markets. Instead, these investors have less tolerance

for missteps and less time to regain lost ground with every year that passes. The baby

boomers are now largely satisfied with single-digit returns that match their

retirement needs and keep pace with inflation. From 1926 to 2006, the average return

for the U.S. stock market was 10.3%. However, during this period, the S&P 500 did not

provide an annual return within plus or minus four percentage points of that average in 72

of the 82 years.

Few advisors and investors realize the mathematics of loss. A 15% loss means an 18%

gain the next year in order to break even. If a plan is expecting a 10% annual return, a

15% loss would require a 29.4% gain the next year or 13.8% for each of the next two

years.

FINANCIAL PLANNING 4.3

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HOW THE EXPERTS ALLOCATE

Harry Markowitz, who shared the economics prize in 1990 for his mathematical

explorations of the relationship between risk and return, has 50% of his portfolio in

stocks and the other half in bonds. John Bogle, founder of Vanguard funds, believes

investors should rebalance their portfolios on a regular basis—yet, he has not made a

change in his portfolio since March of 2000. The managing director of Morningstar, Don

Phillips, recommends putting tax-inefficient assets in retirement accounts. Mr. Phillips

owns TIPS and REITs outside his retirement plans. The author of the classic 1973 book,

A Random Walk Down Wall Street, Burton Malkiel argued that a blindfolded chimpanzee

throwing darts at the stock tables of The Wall Street Journal could pick a portfolio as

well as a money manager. Malkiel admits that at any given time, a fourth to a third of his

money is in individual stocks.

NO REQUIRED 2009 IRA WITHDRAWAL

Normally, IRA owners should begin withdrawing money from their accounts by April 1st

of the year they turn 70 ½. There has always been a one-time exception: the first (and

only the first) withdrawal can be postponed until April 1st of the year after they turn 70 ½.

Thus, someone who turned 70 ½ in 2008 could postpone his or her first withdrawal until

April 1st, 2009—another withdrawal would have to occur by December 31

st of 2009 (to

make up for the withdrawal that was not taken out in 2008). The law has no impact for

those who are required to make a 2008 withdrawal, only for those who would have

normally been required to take any kind of withdrawal in 2009. For taxpayers who

inherited an IRA and are liquidating the account under the five-year deadline, the 2009

withdrawal can be skipped. This means the five-year deadline would be extended to six

years.

FINANCIAL PLANNING 4.4

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PROTECTING RETIREES FROM THEMSELVES

In the 2008 book, Predictably Irrational, MIT Professor Ariely writes, “social norms,

expectations and emotions guide investors more than reason. T. Rowe Price and others

have found that retirees have a strong, but incorrect, belief that their nest egg, regardless

of size, will provide more income than it can realistically generate.” Listed below are T.

Rowe Price suggestions for marketing to pre-retirees:

[1] Ask open-end questions and listen.

[2] Figure out what motivated the client to come to your office and what he expects from

the meeting.

[3] Show a variety of options, from super-conservative to overly aggressive.

[4] Provide planning options (e.g., work longer, increase savings, etc.).

[5] Discuss guaranteed products such as variable annuities with living benefits.

[6] Convey the value the advisor adds to their investment, both short- and long-term.

[7] Emphasize asset allocation and portfolio modeling.

[8] Stress that withdrawals rate above 4% (adjusted for inflation) can shorten portfolio

longevity.

[9] Deliver a unique experience, both in presentation and solution.

[10] Suggest delaying retirement until after age 62 or increase savings rate.

WHEN THE ORDER OF GAINS AND LOSSES MATTER

A $100,000 in the S&P 500 grew to over $2 million for the 25-year period 1978-2002; a

13% average annual return. If the order of returns were reversed (e.g., use 2002 returns

for 1978, 2001 returns for 1979, etc.), the annualized return figure and ending value

would be the same. However, if someone had a $100,000 in the S&P 500 at the

beginning of 1978 and took out 5% each year ($5,000), adjusted for 4% inflation after the

first year ($5 in 1978, $5.2k in 1979, etc.), he would have ended up with $1,115,000 by

the end of 2002. Reversing the order of returns, the same investor would have ended up

with just $373,000. Thus, the order of returns does become important for retirees or

anyone relying on a portfolio for current annual income.

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ECONOMICS

ECONOMICS 5.1

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5.RECESSION MEASUREMENT

Before 2008, the smallest gain for the decade was 2001, when GDP rose 0.8%. The last

time annual GDP was negative was 1991 (-0.2%). Two consecutive quarters of

declining output generally defines a recession. The official call must come from the

National Bureau of Economic Research, which tracks five key gauges: GDP (quite

volatile and often revised), sales and income, industrial output and employment.

The current recession began in December 2007. Since the Great Depression, only two

recessions have run longer than this one, the first ending in 1975 and the other in 1982.

Each of these two recessions lasted 16 months. If the December 2007 recession extends

past March 2009, it will be the longest since the 1933 recession, which lasted 43 months.

The next table, from the National Bureau of Economic Research, lists all of the

recessions since 1933 and their duration (in months).

U.S. Recessions Since 1933

[Duration/number of months in parentheses]

December 2007 to present April 1960 - February 1961 (10)

March 2001 - November 2001 (8) August 1957 - April 1958 (8)

July 1990 - March 1991 (8) July 1953 - May 1954 (10)

July 1981 - November 1982 (16) November 1948 - October 1949

(11)

January 1980 - July 1980 (6) February 1945 - October 1945 (8)

November 1973 - March 1975 (16) May 1937 - June 1938 (13)

December 1969 - November 1970

(11)

August 1929 - March 1933 (43)

2008 BANK FAILURES

It appears that 25 banks failed in 2008 and it appears that at least another 200 banks may

collapse sometime during 2009.

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STOCKS

STOCKS 6.1

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6.BULL AND BEAR MARKET CYCLES

The next table lists indexes and how they fared during bull and bear markets from the

beginning of 2000 to 2008 (source: Thomson Reuters Lipper).

Bull and Bear Markets [2000 through 2007]

Bear Bull Bear Bull Bear Bull

Index

1/14/00

to

3/22/01

3/22/01

to

5/21/01

5/21/01

to

9/21/01

9/21/01

to

3/19/02

3/19/02

to

10/9/02

10/9/02

to

10/9/07

DJIA -19.9% +20.7% -27.4% +29.1% -34.5% +94.4%

DJ WI 5000 -24.7% +18.6% -26.4% +23.9% -32.4% +133.5%

Gold -7.5% +4.2% +6.4% +0.8% +9.3% +130.2%

EAFE -29.1% +12.5% -27.5% +18.5% -27.3% +172.5%

NASDAQ 100 -54.1% +20.6% -45.1% +33.5% -46.3% +168.9%

Russell 1000 -22.6% +18.2% -26.5% +22.7% -33.1% +127.2%

Russell 2000 -13.5% +19.5% -26.2% +34.1% -34.7% +174.6%

S&P 500 -22.7% +17.7% -26.1% +22.0% -33.0% +120.7%

3-Month T-Bill +6.9% +0.6% +1.1% +0.9% +0.9% +14.8%

STOCKS 6.2

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LARGEST DOW PERCENTAGE GAINS

The next table lists several the largest percentage gains for the DJIA (source: WSJ

Market Data Group). Notice that all but two of these top 10 gains occurred in 1929 and

early 1930s.

Biggest Dow Percentage Gains

Date Close Point Gain % Gain

March 15, 1933 62.1 8.3 15.3%

October 6, 1931 99.3 12.9 14.9%

October 30, 1929 258.5 28.4 12.3%

September 21, 1932 75.2 7.7 11.4%

October 13, 2008 9387.6 936.4 11.1%

October 21, 1987 2027.8 186.8 10.1%

August 3, 1932 58.2 5.1 9.5%

February 11, 1932 78.6 6.8 9.5%

November 14, 1929 217.3 18.6 9.4%

December 18, 1931 80.7 6.9 9.3%

COMMODITY VS. STOCK PRICES

A 2004 paper shows that during the worst-performing months for stocks between 1959

and 2004, commodities gained 1.4%. One of the authors, Yale’s K. Geert Rouwenhorst

points out that during five of the nine months in 2008, commodities and stocks moved in

opposite directions. During the last several months of 2008, stocks and commodities both

suffered severe losses.

STOCKS 6.3

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2009 PROJECTED EARNINGS FOR THE S&P 500

At the beginning of October 2008, Thomson Financial reported that the consensus on

Wall Street was that S&P 500 earnings would increase 47% from the fourth quarter of

2007; as of early January 2009, it is believed that earnings actually fell 15% during the

same period. Surprisingly, analysts expect S&P 500 earnings to be flat for 2009

according to Thomson, but show a 33% year-over-year rebound in the fourth quarter of

2009. Goldman Sachs analysts expect U.S. business spending to fall 13% in 2009 and

7.6% in 2010. The earnings slump began in 2007 and since then, earnings have fallen six

quarters in a row (through 12/31/08), the worst continuous drop on record.

In December of 2008, Barron’s asked a dozen experts to forecast how the S&P 500

would do for the 2009 calendar year. Not one of these experts predicted the market would

drop. All of them predicted gains of 5%-38%, with a 13% median.

History shows that the vast majority of time, the stock market does almost nothing.

According to Professor Javier Estrada, a finance professor at IESE Business School in

Barcelona, Spain, if you took away the 10 best days of the stock market, two-thirds of the

cumulative gains produced by the Dow over the past 109 years (1900-2008) would

disappear. If you had missed the 10 worst days, you would have tripled the actual return

of the Dow. The 10 days represent just 0.03% of the Dow’s record during those 109

years—10 days out of 29,694 trading days.

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ANNUITIES

STOCKS 7.1

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7.INTERESTING ANNUITY FACTS

According to ImmediateAnnuities.com, $100,000 invested in an immediate

annuity will provide a 60-year-old (2008) couple with about $6,875 per year for

life, with no decrease in benefits when the first spouse dies. As interest rates rise

in the future, the dollar amount should increase.

The Teachers Insurance & Annuity Association began in 1918 as a pension fund

for college educators. Due to increasing life expectancies, a TIAA task force was

created in 1950-1951 to examine markets back to 1880. The task force concluded

that investing retirement money solely in fixed income was unwise because of

inflation. Because of this conclusion, TIAA created College Retirement Equities

Fund in 1952, the first U.S. variable annuity.

Of the four major living benefits offered by variable annuities, the most popular is

the guaranteed minimum withdrawal benefit (GMIB). This benefit allows a

minimum annual withdrawal of 5-7% of premium, until the entire principal has

been recovered. If the contract experiences positive returns, the income stream can

last significantly longer than 14-20 years.

During 2007, the average variable annuity offered 52 subaccounts (source:

NAVA).

The “typical” annuity owner is female, age 66, has an annual household income

below $75,000 and is (or was) a professional such as a doctor, lawyer, teacher or

owner of a business.

During the first half of 2008, the five biggest sellers of variable annuities were

ING, AXA, TIAA-CREF, MetLife and Lincoln National. These five companies

accounted for over 40% of all variable annuity sales.

STOCKS 7.2

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EIAS BECOMING SECURITIES

On December 17th

, 2008, The SEC adopted Rule 151, which considers indexed annuities

securities. Beginning January 12th

, 2011 equity indexed annuities (EIAs) will be

considered securities and under the jurisdiction of the SEC. The new definition applies

only to equity indexed annuities issued on or after the January 12th

date. The rule

establishes standards for determining when EIAs are not considered annuity contracts.

The SEC rule provides that an indexed annuity is not an “annuity contract” if the amounts

payable by the insurer under the contract are more likely than not to exceed the amounts

guaranteed under the contract.

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MISCELLANEOUS

Miscellaneous 8.1

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8.MONEY MARKET FACTS

Reserve Management Company offered the first money market fund in the early 1970s.

This New York money market fund “broke the buck” in September 2008. The Reserve

fund owned $785 million of Lehman debt when the investment bank filed for bankruptcy

on September 5th

, 2008. The fund wrote down the debt to zero, thereby reducing its NAV

to 97 cents a share.

Prior to this, there had been just one occasion when a fund broke the buck. This earlier

instance occurred in 1994 when a small fund, Community Bankers U.S. Government

Money Market Fund sustained losses in financial derivatives; the fund was geared

towards institutions so no small investor lost money.

Before Reserve Management incurred the September 2008 problem, there had been at

least 20 other instances wherein fund companies (e.g., Bank of America, Northern Trust

and Wells Fargo) also incurred money market losses. However, in all such instances, the

fund company stepped in and made the fund whole.

The average annual expense ratio of a money market fund is 0.58% according to

Morningstar. Money market funds as a whole: [a] hold about 20% of all municipal debt

outstanding, [b] hold about 20% of all marketable Treasury bills and [c] hold more than

40% of outstanding U.S. corporate commercial paper.

2008 REIT RETURNS

Of the 114 stocks tracked by the Dow Jones Equity All REIT Index, only four posted

positive returns for 2008; overall, this index had a total return of -40% for the year. Of

the 114 equity REITs tracked by Dow Jones, 44 had losses greater than -50%; 10 were

down 80% or more.

Miscellaneous 8.2

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HEDGE FUND LEVERAGING

Hedge funds have now learned the ugly side to leveraging. By borrowing from banks, a

hedge fund is able to invest $10 for every $1 of investor money. Although 10-to-1 is

extreme, Long-Term Capital Management (and others) leveraged 30-to-1 in the late

1990s. The problem that hedge funds run into is when the underlying bank collateral

starts to drop in value. Such collateral is “called” when a fund loses 25% of its value.

Such a drop creates forced selling, pushing security market prices (and collateral) even

lower.

ALTERNATIVE ASSETS

Between 2002 and 2002, as stocks collapsed, endowments led by Yale beat the S&P 500

by huge margins thanks to alternative assets. In 1995, endowments had less than 10% of

assets in alternatives; by 2008, the average had climbed to more than 30% (41% in the

case of Columbia University).

In 2007, Laurence Siegel, research director for the $11 billion Ford Foundation, wrote a

paper waning that alternatives could suck the liquidity out of institutional portfolios. His

argument was simple: If you used to rely on bonds to generate income, but you sell the

bonds to make room for alternatives, there is little left to raise cash for capital needs or to

fund operating budgets.

Many hedge funds tie up investors’ capital for as long as three years. The typical private-

equity fund (an “alternative”) makes “capital calls,” requiring investors such as

endowments to pony up another 50-75 cents for every dollar they have already

committed. Columbia is on the hook for another $1.6 billion in capital calls through

2012. With no gains to be found, many institutions are short on liquidity just when they

need it most.

CONVERTIBLES

Hedge funds are a major player in the $200 billion convertible-bond market. These

securities took a large hit during 2008. In one month (October 2008), the average

convertible-bond hedge fund lost 35%.

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TAXES

Taxes 9.1

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9.2009 TAX CHANGES

The estate tax exemption for 2009 is $3.5 million, up from $2 million in 2008. The top

federal estate tax rate remains at 45%. The annual gift tax exclusion increases from

$12,000 to $13,000 for 2009; lifetime gift-tax exclusion remains unchanged at $1 million

(note: the annual gift limitation does not reduce the $1 million amount).

The basic standard deduction for a married couple is $11,400 ($5,700 if single) for 2009,

up from $10,900 ($5,450 if single) for 2008. The amounts are higher for those age 65 or

older, blind or if the taxpayer paid real estate taxes.

Someone under age 50 can contribute up to $16,500 in a 401(k) plan for 2009; those 50

and over can add an additional $5,500 (or a total of $22,000). For 2009 only, those 70 ½

or older are not required to take money out of a traditional IRA and certain other

retirement plans.

The maximum amount of earnings subject to Social Security taxes rose to $106,800 for

2009, up from $102,000 in 2008.

Taxpayers who use their vehicles for work can deduct their actual costs or rely on the IRS

standard mileage rate, 55 cents a mile for 2009.

For 2009, most taxpayers will begin to lose some of the value of their itemized

deductions if their AGI exceeds $166,800, up from $159,500 in 2008.

As in past years, the IRS and a number of software companies are offering free tax

preparation and e-filing services for those with an AGI of up to $56,000 (known as the

“Free File” program). For 2009, the IRS is providing this free service to most people,

even if their incomes are well above the previous limits; this new option is expected to be

limited.

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Federal Income Tax Brackets [2009 vs. 2008]

Rate 2009 Married 2008 Married 2009 Single 2008 Single

10% < $16,700 < $16,050 < $8,350 < $8,025

15% 16,700-67,900 16,050-65,100 8,350-33,950 8,025-32,550

25% 67,900-137,050 65,100-131,450 33,950-82,250 32,550-78,850

28% 137,050-

208,850

131,450-

200,300

82,250-171,550 78,850-164,550

33% 208,850-

373,950

200,300-

357,700

171,550-

372,950

164,550-

357,700

35% > 372,950 > 357,700 > 372,950 > 357,700

AVOIDING AN IRS AUDIT

The IRS audited 1.01% of all individual income tax returns last year; the year before the

figure was 1.03%. Both of these numbers are quite a bit lower than figures for the 1990s.

The IRS has increased their review of individual returns with taxable income of $200,000

or more. A taxpayer’s chances of being auditing rise under any of the follow situations:

[a] self-employed, file a Schedule C and deal in large amounts of cash

[b] if it is suspected the taxpayer is hiding income abroad

[c] claiming unreasonably high deductions in relation to income

[d] numbers on a return do not match what the IRS received from an employer

[e] numbers do not match what a financial institution reported to the IRS

[f] a tip from an ex-business partner, ex-spouse or neighbor

[g] investment in an abusive tax shelter

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SOCIAL SECURITY

Social Security 10.1

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10.ONLINE SOCIAL SECURITY APPLICATIONS

A person who goes into a Social Security office to apply for retirement benefits spends

about 45 minutes consulting with a field officer. A new online application allows people

to apply for retirement benefits in 15 minutes. According to Social Security, over the next

20 years, 10,000 people each day will become eligible for retirement benefits.

The online program has no paper forms to sign and usually requires no additional

documentation. Those with more complicated questions can still call the agency or visit

an office. To use the online program go to www.socialsecurity.gov.

2009 SOCIAL SECURITY INCREASE

More than50 million seniors will see their Social Security benefits increase 5.8% for

2009, the biggest cost-of-living increase in more than 25 years. For the average Social

Security recipient, translates into an extra $63 a month, or $103 per couple.

It is estimated that 21% of retirees rely on Social Security for 100% of their income, 13%

rely on these benefits for 90-99% of their income, 31% for 50-89% of income and 35%

for less than 50% of their monthly income.

SOCIAL SECURITY FOR MARRIED COUPLES

The Senior Citizens’ Freedom to Work Act of 2000 included a “file and suspend”

provision that permits spouses to collect spousal benefits when the primary worker is

postponing Social Security retirement benefits. Often times, the best strategy is to:

[1] have the lower-income spouse start to receive full retirement benefits when this

person turns 65 (or 1-2 years later depending upon the recipient’s date of birth);

[2] have the high-income spouse “file and suspend” his benefits as soon as he receives

full retirement (age 65-67, depending upon date of birth);

[3] have the high-income spouse receive spousal benefits from Social Security for the

years for the years 66-70 and

Social Security 10.2

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[4] have the high-income spouse change over at age 70 and begin receiving his maximum

Social Security benefits [which would now include cost-of-living adjustments (COLA)

and delayed retirement credits (DRC)]—thereby no longer receiving 50% of the spousal

benefit from the lower-income spouse.

By delaying benefits until the maximum age of 70, the higher-income spouse maximizes

his Social Security benefits (receiving about 85% more in monthly checks than he would

have if benefits had begun at age 66. Additionally, the high-income spouse still received

50% of the lower-income spouse’s full retirement benefit for those “bridge” years (from

age 65 or 66 to age 70). The idea behind this strategy is to maximize (by waiting until age

70) Social Security retirement benefits by taking advantage of inflation (COLA)

adjustments as well as upward adjustments for delayed retirement credits (DRCs) from

full retirement age of 66 until age 70 (note: after age 70 there are no additional DRCs).