September 30, 2001

I would like to express my deepest sympathies to those who lost family, friends, and colleagues in the tragic events of September 11. This was truly a horrific event- the consequences of which are still unfolding as I write.

Last week’s terrorist attacks clearly rattled investors, as evidenced by a 7% plunge in both the DJIA and the NASDAQ Composite Index when U.S. markets reopened from a four-session shutdown. The broad market as measured by the S&P 500 index lost 15% and the NASDAQ lost 31% in this last quarter. More than 99% of stock funds lost money in this quarter. But many folks, of course, were already badly shaken. Over the past 18 months, stocks have slumped amid escalating investor nervousness. Over the past 12 months, stock funds are down some 27%. History suggests that the current decline of 25% should be pretty near a bottom.

The tech-heavy NASDAQ has fallen 70% in the past 12 months but is still up over 350% since October 1990. This sector is where most of you have heavy losses. Will I sell? To sell now and create a capital loss in order to buy another fund that may have an end of the year capital gain distribution is not prudent. The technology sector made up a small percentage of most of your portfolios. Those with large portfolios of technology we have reviewed and rebalanced. Do I still believe in keeping a small portion in technology holdings? Definitely-yes. As the Baby Boomer generation moves into retirement, industry will face the need to service the largest generation of retirees in our nation’s history, and they’ll need to do it with a shrinking supply of labor. Companies will have no choice but to increase their level of automation, upgrade their technology, and heighten their efficiency to meet this challenge.

The Federal Reserve and all Central Banks have pledged to engage in a coordinated effort to keep the worst terrorist attack in U.S. history from destabilizing the global economy. The U.S. markets, like those around the world will react negatively short-term. In the near term, events like this promote fear and uncertainty, but typically such reaction is short lived. Looking back at history can be reassuring because we see that markets usually react to shocking events in a "V" shape pattern, with a sudden drop followed by a quick rebound, with little long-term effect.

What you can do-tighten your belt. Even if your investment losses haven’t been too steep, the combination of a declining market and your own spending could still devastate your nest egg. How much can retirees safely pull out of their portfolio each year? Answers vary- but a general rule of thumb is 5%. If you are taking $25,000 a year, cut back to $22,000 until the whole thing blows over and you will be surprised how effective that can be in extending the life of your portfolio.

One study examined the performance of the Dow Jones Industrial Average after 26 specific "crisis events" since 1940, including the attack on Pearl Harbor in 1941, the Cuban Missile Crisis in 1963, the Arab oil embargo in 1973, and the market crash of 1987. During the initial reaction period following these events, the median drop in the DJIA was -6.20%. In the one month following these events, the median drop in the DJIA was -6.20%. In the one month following each drop the index had gained on average +4.20%; in three months +6.7%, in six months +12.1%. Keep in mind that the U.S. and foreign financial markets have already corrected a great deal in the last 18 months.

I believe that frequent switching of mutual funds is misguided and self-destructive. The dramatic cost of shifting was captured in a Dalbar study report in the March 2000 issue of Mutual Funds Magazine that noted: ‘between 1984 and the end of 1998, the average stock fund gained 509%, or 12.8% a year over 15 years. Meanwhile the typical mutual fund investor, whose average holding period was less than three years, earned just 186%, or 7.25% a year’, a self-inflicted cost of over 300%.

There is no need to panic and sell when prices are low. Indeed, you could argue that now is the time to buy. Isn’t that the way it is supposed to be? If you want to profit from the stock market, you buy low and sell high- not the other way around.

No economic decline in the United States since 1930 lasted more than two years and markets typically recover before the economy. Remember that 10 years ago the NASDAQ was at 340, and today it hovers around 1,500. Equity prices always rise more than most people can imagine. If you agree that the market will rise someday to 5000, then what the market does over the next 3 months is really meaningless, because nothing that matters in the next three months will matter at all 10 or 20 years from now. I don’t like to lose money today any more than you do. But when given a choice between the uncertainty of short-term market movement and the certainty of financial security that the stock market grants to its long-term investors, I’m going with the long-term winner. We all have a fundamental decision to make: wonderful security at one end of our investment life, and terrible insecurity on the other end. The choice is which order you prefer.

In Are Short-Term Performance and Value Investing Mutually Exclusive? Eugene Shahan analyzed the investment performance of seven money managers, about whom Warren Buffett wrote in his article, The Super-investors of Graham and Doddsville. Over long periods of time, the seven managers, significantly outperformed the market as measured by the DJIA or the S&P 500 by between 7.7% and 16.5% annually. (The goal of most institutional money managers is to outperform the market by 2% to 3%.) However, for periods ranging from 13 years to 28 years, this group of managers underperformed the market between 7.7% and 42% of the years. Six of the seven investment managers underperformed the market between 28% and 42% of the years. In today’s environment, they would have lost many of their clients during their periods of underperformance. Longer term, it would have been the wrong decision to fire any of those money managers.

Most people instinctively know that if the market for real estate is not good, they are wise not to try to sell their house. They know that if someone is unwilling to pay what the house is worth, they simply should not sell. They correctly wait until the market recognizes the value they have always been able to see in their property. But the same people abandon their common sense when it comes to equity investing. Too many people panic when the market under-appreciates the value of the companies whose stock they own. Rather than patiently waiting for the market to recognize the true value of stocks, they sell and incur unnecessary losses. Charles Ellis, a leading researcher in the investment field, has found that investors’ returns are lost by making mistakes such as switching funds too often, buying high and selling low, and paying taxes unnecessarily.

We all have our cash stashes. Our savings, our emergency fund, our big purchase-coming- up fund and our I -don’t- want it-in-the-market right now money. Whatever you want to call it, we all have money that we’re holding for the short term. It‘s not the money you can afford to take chances with, but heck, you’d still like to earn a decent return. By the 1990s, most of us had discovered the money market fund. The problem is that the Fed’s rate cuts have dragged savings yields down across the board. That means that the return on your cash is probably hovering somewhere within spitting distance of dismal right now. But it is a new Millennium and you have an alternative for your savings that you should consider. It’s what is known as an "ultra short" bond fund. Which means you get a higher yield potential than money market funds in exchange for a little share price fluctuation. As the Wall Street Journal said in an article about declining savings rates, "The good news, though is that money fund investors can engineer a nice increase in yield without taking on huge added risks. Among the best options to consider: ultra-short and short term bond funds." What’s the catch? These funds are not FDIC insured, and do not maintain a fixed share price like a money market fund. However, you do get full access to your cash at any time and most funds have returned more than the average money market fund every year but two out of the last ten-without a single down year in the bunch.

A new California Civil Code became effective on July 1, 2001. It created a new property title, "Community Property with Right of Survivorship". This new property title combines "Joint Tenancy" and "Community Property" into one title for both probate purposes and assures that upon the death of either spouse a step-up in basis of both halves of community property will occur. Under present law, if the property is proved not to be community, then only the deceased spouse’s portion receive the step-up in basis, and generally this is highly undesirable. If you were refinancing your house, this would be an excellent to change the title.

The Fed cut interest rates for the ninth time and added over $70 billion of liquidity to the market following the terrorists’ attacks. The Fed funds rate now stands at 3%. Central banks around the world are beginning to act in unison to restart a stalled global economy. An additional cut of .25% during the October 2nd Fed meeting appears to be likely. This means that most money markets will pay 2-3% in the future- hardly keeping up with inflation. Falling interest rates have repeatedly revived economic growth in every sluggish period since World War II. The tragedy that unfolded last month should only delay the recovery process, not prevent it. Additional bills are being discussed to reduce taxes and increase government spending in order to stimulate the economy.

If Advanced Financial Designs is managing your money, please feel free to contact the office if you have concerns about your portfolio at no cost.

Financial planning has become quite popular and we have seen a tremendous growth in the number of people who want our services this year. In order to accommodate all of you, I find it necessary to change our structure. I will be sending a new outline of services for clients towards the end of the year. Basically, you will be able to pick and choose the services you would like each year from several programs. Although our average account size is large, I do not like to turn anyone away due to lack of funds. Therefore, I am also developing a web-based program for do-it-your-selfers and those who are just starting to accumulate assets.

If this crisis continues, I will be sending email alerts to clients. Please make sure that I have your current email address. Also, look to my website (www.afdavisors.com) for updates on investment and market commentary. Unfortunately, we cannot email quarterly statements.

While holding firm to your investments in difficult markets can be trying, a long-term approach to investing is generally the most successful. We will continue to work diligently to try to obtain the best risk adjusted returns for your investment through our continued dedication to thorough research and solid investment practices.

Peace will prevail on Earth and let it start with me…

- Fern Alix LaRocca CFP® EA