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December 2006 performance review

January 17, 2007

p>In December, the S&P500 climbed 1.40% and the Dow 2.11%, while the NASDAQ slipped 0.68%. Small cap stocks rose, but only 0.34% (as measured by the Russell 2000 index), and bonds were weak as interest rates inched back up. The Lehman Brothers Long Term Treasury Index was down 2.14%, while the Vanguard Total Bond Index, which is less sensitive to interest rate shocks, fell by just 0.48%.

 

Stocks performed very well in 2006. Other than Japan, you would be hard pressed to find a stock market index anywhere in the world that was not up (and most by 10% or more) for the year. Even the fund categories that were lagging a few months ago, such as emerging markets and small cap, rebounded and then some.

Investors did not have to get too creative. The boring old Dow Jones Industrial Average led U.S. indexes with a 19.05% return in 2006. The Russell 2000 managed to post a strong 18.36% showing, beating out the S&P500’s 15.79% move by a small margin. The NASDAQ was the real laggard, with “just” a 9.51% return. The larger, better known stocks from the NASDAQ – those in the NASDAQ 100 – were even weaker, up just 6.82% - barely above a good low-fee money market fund.

Bonds performed poorly in 2006, though not as bad as many feared.  The long-term bond index posted a total return of about 2%, while the Vanguard Total Bond Index was up 4.27%. In such an environment, shorter term bond funds (like our Vanguard Short Term Investment Grade - VFSTX) performed better than many bond funds.  High yield bonds had nearly double-digit returns in 2006 as investors flocked into higher risk asset classes, helping some of our portfolios.

Most of our stock funds were up nicely in 2006, with just a few missing double digit territory (only T. Rowe Price Japan was negative for the year). The laggards, like Buffalo Mid Cap (BUFMX), up just over 6% in 2006, were mostly in NASDAQ stocks and healthcare names. Healthcare, notably biotech stocks, was a weak sector in 2006.

We have just added biotech funds to some of our higher risk portfolios. Unlike last year’s big sector allocation, telecom, these funds are quite risky. We have already seen downward swings of almost 10% in recent weeks. For the record, last year’s telecom selection, Vanguard Telecom ETF (VOX), was up 36.85% – the #11 best performing ETF of the year, and the #2 ETF investing in U.S. markets.

In general, indexes were harder to beat in 2006 than in recent years, as larger cap stocks – heavily weighted in most indexes - stopped lagging behind smaller cap stocks.

With the S&P500 up 15.79% and the Vanguard Bond Index up 4.72%, we are happy with something between those two extremes, given that in 2006, all of our portfolios held bonds for the entire year. Our portfolio returns ranged from a low of 7.57% (Safety) to a high of 12.13% (Aggressive Growth) in 2006. We did better on the low-risk side in 2006, with solid returns of 7.57%, 8.14%, and 11.13% for our Safety, Conservative, and Moderate portfolios, respectively, given the lower risk and higher bond stakes. Growth, Aggressive Growth, and Daredevil were up 10.52%, 12.13%, and 11.04%, respectively. All of our model portfolios have beat the S&P500 since launched in April 2002.

Our Conservative Portfolio was up 0.33% in December, and was up 8.14% for the year.

The driving force behind the higher returns for a portfolio largely composed of bonds for most of the year was our 5% stake in Vanguard Telecom ETF (formerly VIPER) (VOX), which we sold at the end of October.

International stocks continued to outperform U.S. stocks. SSgA International Growth (SINGX) was up 19.93% in 2006 and 3.08% in December alone.

The Vanguard U.S. Value Fund has been helping of late, and we are up 10.34% since we added the fund at the end of February. 

High yield (junk) bonds beat investment grade bonds in 2006. The Vanguard High Yield Corporate Fund (VWEHX) rose 8.24% for the year, boosting the portfolio. The fund was up almost 1% in December, while other bonds fell.

The U.S. dollar had another bad year, which boosted the American Century International Bond (BEGBX). The fund was up 8.26%.

In December, the S&P500 climbed 1.40% and the Dow 2.11%, while the NASDAQ slipped 0.68%. Small cap stocks rose, but only 0.34% (as measured by the Russell 2000 index), and bonds were weak as interest rates inched back up. The Lehman Brothers Long Term Treasury Index was down 2.14%, while the Vanguard Total Bond Index, which is less sensitive to interest rate shocks, fell by just 0.48%.

Stocks performed very well in 2006. Other than Japan, you would be hard pressed to find a stock market index anywhere in the world that was not up (and most by 10% or more) for the year. Even the fund categories that were lagging a few months ago, such as emerging markets and small cap, rebounded and then some.

Investors did not have to get too creative. The boring old Dow Jones Industrial Average led U.S. indexes with a 19.05% return in 2006. The Russell 2000 managed to post a strong 18.36% showing, beating out the S&P500’s 15.79% move by a small margin. The NASDAQ was the real laggard, with “just” a 9.51% return. The larger, better known stocks from the NASDAQ – those in the NASDAQ 100 – were even weaker, up just 6.82% - barely above a good low-fee money market fund.

Bonds performed poorly in 2006, though not as bad as many feared.  The long-term bond index posted a total return of about 2%, while the Vanguard Total Bond Index was up 4.27%. In such an environment, shorter term bond funds (like our Vanguard Short Term Investment Grade - VFSTX) performed better than many bond funds.  High yield bonds had nearly double-digit returns in 2006 as investors flocked into higher risk asset classes, helping some of our portfolios.

Most of our stock funds were up nicely in 2006, with just a few missing double digit territory (only T. Rowe Price Japan was negative for the year). The laggards, like Buffalo Mid Cap (BUFMX), up just over 6% in 2006, were mostly in NASDAQ stocks and healthcare names. Healthcare, notably biotech stocks, was a weak sector in 2006.

We have just added biotech funds to some of our higher risk portfolios. Unlike last year’s big sector allocation, telecom, these funds are quite risky. We have already seen downward swings of almost 10% in recent weeks. For the record, last year’s telecom selection, Vanguard Telecom ETF (VOX), was up 36.85% – the #11 best performing ETF of the year, and the #2 ETF investing in U.S. markets.

In general, indexes were harder to beat in 2006 than in recent years, as larger cap stocks – heavily weighted in most indexes - stopped lagging behind smaller cap stocks.

With the S&P500 up 15.79% and the Vanguard Bond Index up 4.72%, we are happy with something between those two extremes, given that in 2006, all of our portfolios held bonds for the entire year. Our portfolio returns ranged from a low of 7.57% (Safety) to a high of 12.13% (Aggressive Growth) in 2006. We did better on the low-risk side in 2006, with solid returns of 7.57%, 8.14%, and 11.13% for our Safety, Conservative, and Moderate portfolios, respectively, given the lower risk and higher bond stakes. Growth, Aggressive Growth, and Daredevil were up 10.52%, 12.13%, and 11.04%, respectively. All of our model portfolios have beat the S&P500 since launched in April 2002.

Our Aggressive Growth Portfolio was up just 0.26% in December. For the year, the portfolio was up 12.13%.

Helping our portfolio most of the year was our 5% stake in Vanguard Telecom ETF (VOX) (formerly Vanguard Telecom VIPER). Since adding this to the portfolio at the end of February 2006, the fund is up 24.69%.

International stocks continued to greatly outperform U.S. stocks, but Japan was a near stand-alone laggard in 2006. T. Rowe Price Japan (PRJPX) was down 5.67% for the year. If Japan continues to underperform other fund categories, we may increase our stake and raise our category outlook (both lowered in recent years after strong performances).

Larger cap stocks have been strong most of the year, with Bridgeway Blue-Chip 35 (BRLIX) up 15.43% in 2006.

The healthcare sector performed poorly in 2006 – particularly late in the year when healthcare stocks stalled and other stocks took off. The Healthcare Select Sector SPDR (XLV) was up just 7.09% in 2006.

Biotech stocks fell sharply in December, with the new high-risk holding of SPDR Biotech (XBI) down 8.70% for the month.

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