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July 20, 2010

Dear Clients and Friends:

Market volatility in the second quarter was a reminder of the battle still taking place between the forces of recession and recovery. During times of extreme uncertainty, we often find it beneficial to step back and review the big picture.

The 10,000 Foot View

We, as investors, can easily become overwhelmed by the ups and downs of the stock market without keeping the bigger picture in context. The media plays a key role in keeping our attention fixated on annual, quarterly, even daily returns. We do so at our own peril. As the market falls, the flight or fight part of our brain, which has allowed us to survive for generations, kicks into overdrive. This natural emotional response to a threat (loss of money) poses a real threat of derailing us from what really matters, reaching our goals. For most of us, this means running out of life before we run out of money.

To accomplish this, we need to earn an adequate real (inflation-adjusted) return over time, while at the same time, minimizing portfolio downturns while making withdrawals. Unfortunately, minimizing downside volatility usually comes at the expense of lower returns. "No pain, no gain" very much applies here.

What can we infer about future returns?

Based on the current yield of the 10-year U.S. Treasury, which is currently at 3%, it is reasonable to project a 10-year return on bonds of 4% per year (1% for credit risk above Treasuries). Does this mean that returns will be 4% every year? No. However, there is a reasonable basis for getting 4% annualized, based on where we are today. The path the bond market takes to deliver that return would be impossible to hypothesize.

For stocks, there are a lot more moving parts. To start, the market (S&P 500) is expensive versus the historical average, using a normalized price-to-earnings ratio (P/E) as a gauge. Currently, it carries a P/E of 20, compared to an average of around 14. Growth rates will be subdued going forward because of the debt overhang and high unemployment. Between P/E contraction (P/E’s falling back to 14) and modest economic growth over the next decade, there is a reasonable basis for predicting a 6% return over the next ten years (versus the long term average of 10%). Again, we are not suggesting in any way that the market will deliver 6% per year, but it has a reasonable chance of delivering 6% annualized, based on the price of stocks today. The path the stock market takes to deliver that return would be impossible to hypothesize.

For example, the following annual returns produce a 6% annualized return over a ten year period. The return numbers below correspond to end-of-year portfolio values, assuming an initial portfolio value of $1,000,000:



Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

Year 9


Annual Return











End of Yr $











 The first three years equates to an annualized return of -4%, while the final seven years equates to a 10.7% annualized return. Put them together, and you get a 6% annualized return over ten years. Please note that in this example, the highest return assumed was 32% and the lowest -20% (a 52% spread between the two). A similar table could be illustrated for bonds that achieve 4% annualized, with the only exception that the returns for bonds would have a much narrower spread between the annual returns and the average annualized return (lower deviation).

What can we infer about risk?

The current economic environment leads to heighted volatility in both stocks and bonds. There is a tug of war between deflation and inflation. Between the two, deflation is considered a worse outcome. So while deflation is the overriding concern leading to monetary and fiscal stimulus (low Fed funds rate, quantitative easing, tax incentives, stimulus packages, etc.), the longer term results of the stimulus is inflationary. Heightened government intervention adds to market volatility. Given the historically low bond yields, and above average normalized P/E ratios, we are obviously more concerned about downside volatility.

Given the above forecasted return, how are we designing portfolios?

In summary, we believe that we are in a period of lower than average returns with heighted volatility. So while the destination in stocks and bonds may be 6% and 4% annualized returns over the next decade, respectively, the journey (annual returns) for stocks could look something like the table presented above. In addition to incorporating globally diversified stocks and bonds in different proportions based on client’s individual circumstances, satellite strategies will be used in an attempt to enhance returns by actively managing the decade long journey.

Estate Planning

There is still no progress on amending federal estate law. Meanwhile, some very wealthy individuals have passed away with no federal estate tax in place. The Wall Street Journal estimates that the heirs of George Steinbrenner, majority owner of the Yankees, could save $600 million in federal estate taxes. The Steinbrenner family seems to have escaped the fate of the Wrigley and Robbie families, who were forced to sell the Chicago Cubs and the Miami Dolphins, respectively, to pay estate taxes.

If no action is taken before January of 2011, current estate tax relief expires and we will once again have a limited, $1,000,000 estate exemption. This makes estate planning for individuals (or couples) with gross estates over that amount very important.

Please contact us if you would like to have your planning reviewed in anticipation of the $1 million exemption.

SEC Rule Change

Under Rule 206(4)-2, the SEC now requires advisors to include a legend in statements they prepare urging clients to compare those statements with statements received from custodians.

We will be including the recommended legend in future Portfolio Holding Reports to you and, in addition, will be providing a one page summary that lists each account value and a total that agrees with the total listed on the Portfolio Holdings Report.

Clients should understand that there may still be some small differences when comparing our quarter end values with statements from custodians due to posting of dividends and corrections made after quarter end downloads. Certainly, we encourage you to bring to our attention any differences that cause you concern.

For your own protection, we continue to encourage clients to review all statements for unauthorized transfers or withdrawals.

Annual Offer to Deliver ADV

This is our annual offer to deliver to you our most recent filing with the Securities and Exchange Commission. Please contact us if you would like a copy.

Website Updated

We have updated the look and content of our website. Some design changes were made to facilitate web searches from prospective clients. The address of the website is: www.SDfinancialadvisors.com.

Delaware Today

We anticipate being featured in the August issue as "Five Star Wealth Managers." We want to thank our clients and friends who took the time to respond to inquiries from the magazine, enabling us to be listed.

We continue to work daily to earn your trust and confidence.

Best Regards,

Vincent A. Schiavi, CFP®, CPA/ PFS               Ravi P. Dattani, CFP®, CPA

President                                                       Vice-President







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