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March 2002 Performance Review

April 15, 2002

The Conservative portfolio reflects the areas of the world financial markets in which we feel an investor can safely earn a yield with some opportunity for appreciation. We are weighting toward out-of-favor areas like foreign and high-yield bonds, and passing on areas that are traditionally a larger part of a low-risk portfolio (like longer-term US government bonds). We feel those areas have run up to the point where the future potential is weak.

We like junk (high-yield) bonds right now, primarily because of their relatively weak recent performance. We think they are undervalued in part because of fear caused by recent debt collapses at various high-flying telecom stocks, and the Enron and Global Crossing debacles. Fear is good - it creates value in an otherwise overpriced market. Because junk bonds can be volatile, we've limited them to 10% of this low-risk model portfolio. If they have a bad year, we may increase the stake to 15%. We chose the Columbia High Yield Bond fund as our high-yield bond vehicle because of its low volatility.

While we were very big on bonds 2 years ago when we first started designing allocation portfolios, we are less enthusiastic today. Bonds have had strong returns in the last two years as interest rates have come down across the board. We feel we are at the bottom of an interest rate cycle. While you probably can't go wrong being in any low-fee bond fund, we have focused on foreign bonds as a way to avoid the mediocre returns we are predicting in ultra-safe, longer-term US government bonds over the next year or two. Our foreign bond choice is the excellent, institutional-grade BlackRock International Bond fund. Make sure you buy the no-load class here, ticker symbol CIFIX.

Our US bond choice is the top-notch Harbor Bond fund, which has an extremely low fee and is run by the finest bond investor out there, Bill Gross. Gross' services are available to you through a sub-advisory arrangement with the Harbor Bond fund. Most of the billions under Gross's management are for high-minimum institutional accounts.

The smallish 25% equity stake (REITs, mid-cap value, and utilities) is slightly understated because10% of the portfolio is in a convertible fund, and convertibles are technically bonds that exhibit some stock characteristics. We are going with the very solid Northern Income Equity fund.

We've cut back on funds that invest in REITs (real estate investment trusts) compared to our allocations of a couple years ago, as they have had a very good run-up in price since then. We feel the real estate market is long overdue for a correction. Portfolios #1 and #2 are now our only model portfolios with any REIT allocation, and in those it is only 5%. If REITs continue to rise in price, we may remove the allocation completely by the end of the year.

We are very positive on utilities right now, and have chosen good utilities funds operating at the appropriate risk level for each portfolio. For the safety portfolio, we chose the conservative Strong Dividend Income fund. Its quest for high dividends has caused it to be heavily weighted in utilities and energy/natural resource stocks, two areas we like right now. This fund won't have a huge year if utilities rebound sharply, but it also will not drop significantly if we are off the mark.

Our other value stock pick besides the strong fund is the American Century Equity Income fund. We liked this fund a heck of a lot more a year ago, before it was flooded with new investor assets, but the fund still has some room to grow before it really begins to suffer. We're watching two things right now: asset levels and performance. If this fund breaks about $1.3 billion or so, or if we start seeing a slide in performance, we'll move into one of our backup choices.

The yields of money-market funds have been quite low lately, although they may have bottomed out a few weeks ago after over a year of Fed rate cuts. A couple of years ago, we had money-market fund allocations in all of our model portfolios. Back then, they yielded over 5%. Now, with 1% - 2% yields being the norm, we've pared down these funds for most portfolios. We suggest buying higher-yielding, short-term bond funds instead of using regular money-market funds for this fund's reserve allocation.

We were careful to pick low-minimum funds for all our portfolios, so this portfolio can be created with as little as $25,000 (how much you need to meet all the fund minimums and our target allocations). Many people living off income (type 1 investors outlined in the risk profile above) have more than this, but those that are saving for something like a house and will need the money in a few years may not.

Again, this is a tougher time for bonds than a couple of years ago, so I don't expect this portfolio to have anything better than our expected return of 6.5% this year. Given the low portfolio-risk level and the state of the markets, that's a great return.

The Aggressive Growth portfolio reflects the areas of the world financial markets in which we feel an investor can earn above-average returns from capital appreciation with some opportunity for income as well. We are weighting toward out-of-favor areas like foreign and high-yield bonds, and passing on areas that are traditionally a larger part of a higher-risk portfolio, like large-cap growth and technology, areas we feel are still overvalued even after significant collapses in price.

We like junk (high-yield) bonds right now, primarily because of their relatively weak recent performance. We think they are undervalued in part because of fear caused by recent debt collapses at various high-flying telecom stocks, and the Enron and Global Crossing debacles. Fear is good - it creates value in an otherwise overpriced market. We chose the Northeast Investors fund as our high-yield bond choice because of its low fees and opportunity to appreciate significantly with a rally in high-yield bond prices. This fund is a bit riskier than our lower-risk, high-yield bond fund choices in the other model portfolios.

The 80% equity stake is in higher-risk categories that are positioned well for the near and longer term. Our stock areas of choice are international small-cap stocks, small- and mid-cap value and growth, utilities, and natural resources. 

We've cut back on funds that invest in REITs (Real estate investment trusts) compared to our allocations of a couple years ago, as they have had a very good run-up in price since then. We feel the real estate market is long overdue for a correction. Portfolios #1 and #2 are now our only model portfolios with any REIT allocation, and in those it is only 5%.

We like natural resources, and have chosen a good fund that has global exposure, fitting nicely with our push abroad for many of our investments. The American Century Global Natural Resources fund has low fees, and it's available for no-transaction-fee (NTF) purchase on many discount brokerage supermarkets. This fund might not jump out at aggressive investors, but that's only because it invests in two areas that have been a little out of favor: international and energy stocks. 

Emerging market stocks have been hot so far this year, and that's the only reason we're not totally thrilled about our10% position in the Dreyfus Emerging Markets fund. It's run by one of the best-diversified emerging markets investors around, and it's a fairly safe fund given the markets it's involved in. This fund is quite uncorrelated to US equities, so having this fund in the portfolio lowers overall portfolio volatility.

We hit international small-cap stocks with the recently launched Artisan International Small Cap fund, run by the same managers as the top-rated, but bloated asset-wise from its previous success, Artisan International fund. The only problem here is a high expense ratio. Artisan is pretty greedy, but they run some good funds.

You've all read how bad telecom investing has been, but now may be the time to start looking selectively through the wreckage. While far from a bargain basement even though many of the stocks in this sector are down over 80%, some stocks can't fall much further. Unlike the hordes of trendy "wireless" and "telecom" funds launched at the peak of the market in 2000 (ain't it always the case) that went on to spiral down over 80% (and destroy billions in fund investor wealth in the process), the Gabelli Global Telecom fund is a relative safety net. While down plenty from its highs, the managers avoided many of the largest crash-and-burn stocks that dragged down other telecom stocks. Expect a volatile ride, but this fund is the type we are beginning to look at for tech and growth investing again. We'd increase exposure over 10% if we saw earnings improve in the sector and prices come down further, an unlikely scenario.

We were careful to pick low-minimum funds here, so this portfolio can be created with as little as $25,000 (how much you need to meet all the fund minimums and our target allocations).

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