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January 30, 2008

Dear Clients and Friends,

2006 Financial Asset Performance

The Lehman Brothers Aggregate Bond Index was up 1.24% (4th qtr) and 4.33% (2006). The S&P 500 U.S. stock index was up 6.7% (4th qtr) and 15.79% (2006). Foreign equities, as represented by the MSCI EAFE Index, were up 10.35% (4th qtr) and 26.34% (2006).

We have included a Morningstar table of performance figures for many of the mutual funds in your portfolio, plus some comparative market indices noted by the prefix “Idx”.

Investment Allocation Commentary by Ravi P. Dattani, CFP®, CPA

Over the past few years we have maintained a significant allocation towards international stocks. This has served us well for two reasons. First, the dollar has declined in value versus currencies of other industrialized nations, and second, the local currency performance of international stocks has outperformed the S&P 500. A reasonable explanation for this out-performance is that international stocks were relatively less expensive. No such valuation difference exists today.

Foreign Exporters

The international game has become: get your parts from Southeast Asia, manufacture your product in China, outsource your customer service to India, and sell your product to America. Of course, this isn’t new news, all you have to do for validation is order a new Dell computer.

China and Japan have been accumulating U.S. assets to keep their currencies from rising against the dollar. This process, known in monetary circles as dirty float, is an artificial way of keeping goods competitive in the U.S. market. In other words, a significant portion of U.S. assets, namely treasuries, are being purchased for non-economic reasons (i.e. currency manipulation), not for the interest income being paid.

A good analogy to this situation would be Hewlett Packard sales of color printers. HP has no problem making very little, if any, money on printer sales because they know they will make plenty of money from the sale of ink cartridges. Foreign countries have no problem earning low interest on their U.S. Treasury investments as long as they are able to export more goods to U.S. consumers, whose purchasing power is enhanced by a strong dollar.

The unfortunate consequence to U.S. bond investors is that yields have been lowered as a result of this excessive foreign demand.

Investment Allocation Commentary (Continued)

Oil Producers

The rise in oil prices has led to an ever increasing amount of profits by oil exporting countries, with most recycling these profits into U.S. denominated assets. In early 2006, Russia was virtually alone in its decision to start diversifying away from the dollar, and into Euros. We shall see if this trend is followed by other countries, and if so, if it will be met with resistance by the European Central Bank. After all, Europe has product to sell as well, and they will only tolerate their currency appreciating for so long.

Two of the most consequential questions become: 1) At what point will foreign governments, that are currently more interested in trade exports than interest earned on deposits, change their priorities? and 2) At what point will oil producing countries that are currently stashing their profits in dollar denominated assets decide to start diversifying into the Euro or a basket of non-U.S. bonds as Russia did in 2006? Given our concern over these questions, we are willing to place our bets on a downward trend of the U.S. dollar.

Growth Prospects

The U.S., old Europe and Japan are projected to grow at about the same rate in 2007. However, there is more uncertainty with U.S. growth rates, as economists disagree over the impact of the slowdown in the U.S. housing sector. Developing markets (China, India, Russia, Brazil, etc.) should continue to grow at rates significantly higher than the developed world, albeit with greater volatility.

Global growth is still highly dependent on the U.S. consumer. If we experience a downturn in the U.S. economy and stock market, it could lead to a global sell-off of equities with emerging markets suffering the most.

Conclusion – course of action

We will continue to carry a higher than average exposure to international stocks, mostly to gain exposure to the higher growth areas of the world as well as the long term downward pressure on the U.S. dollar. Although volatility may be greater in high growth regions, we will rely on our international managers’ investment skill to navigate those markets. If indeed, there is a global sell off of equities, our allocation to other asset classes will provide us with some portfolio insurance, and give us the ability to rebalance as opportunities arise.

Bond market experts profess that bond yields are about 1% lower than they would otherwise be as a result non-economic, currency related Treasury bond purchases. Our reason for owning bonds is purely economic, and until the market reflects the proper risk/return trade-off for owning them, we must expand our opportunity set and look for competing investments. As a result, we will trim high quality bond exposure by as much as 20%. With the proceeds, we will look to add exposure to long/short mutual funds, and depending on client’s individual situation, non-publicly traded real estate.

The goal in using non-traditional investments is to add assets classes that will reduce risk without negatively impacting investment returns, or to enhance return without reducing risk. To this end, a long-short strategy is a viable addition to the All Asset fund and some real estate in the non-traditional asset space. A long-short strategy attempts to benefit from buying stocks anticipated to rise and short-selling stocks anticipated to fall. We will be recommending the addition of the Hussman Strategic Growth Fund to provide this long/short strategy exposure. Enclosed is a Morningstar report for your review.

Income Tax Return Information

We encourage you to collect and organize your 2006 tax related information for your tax preparer. Enclosed please find a report of Realized Gains and Losses along with a report of fees paid to Schiavi + Company during 2006. This information should be provided to your preparer to assist in filing your returns.

Please be prepared to receive delayed and amended 1099s. One reason for the delay is a requirement for custodians to include information about tax-free interest. We are aware that several custodians, Fidelity not being one, have asked the IRS for a 30 day extension. Once your returns are finalized, we request that you provide us with copies of your federal and state returns, W-2s and schedules of planned estimated tax payments for 2007.

We realize that there may be legitimate reasons for delaying the filing of your returns. However, we strongly encourage timely filing, which enables us to perform valuable tax planning in the fourth quarter of the year. Note that the IRS has extended the normal filing date for 2006 returns to April 17, 2007, since April 15th falls on a Sunday and April 16th is Emancipation Day, a legal holiday in the District of Columbia. The IRS said holidays observed in the nation’s capital have an impact nationwide.

If you still have funds in a flexible spending account at work, check to see if your employer’s plan allows using those dollars within the first two and one half months in 2007. If you made changes late in 2006 to income tax withholding rates or 401k / 403b elections, reset them to a correct level for 2007.

Please take your time answering your tax preparer’s questionnaire to take advantage of all entitled deductions. Also ask about changes for 2007, so you can retain the proper records going forward. Note, for example, that unacknowledged charitable cash contributions will not be deductible in 2007. You’ll need a receipt from the charity, a canceled check or a credit card statement showing the charge.

Schiavi + Company LLC

As of January 1, 2007, the firm changed its entity status from a Subchapter S Corporation to a Limited Liability Company (LLC). This form of ownership is a better fit for our growth objectives. The change in operating entity will not change our service agreements and should be seamless from your perspective.

As a result of his extraordinary contribution toward our success, Ravi Dattani has been offered, and he has accepted, the opportunity to buy a partial interest in the firm. Ravi’s ownership, and the rewards and responsibilities that go with it, became effective on January 1, 2007. Please join me in welcoming Ravi in his new role.

When the business was started in 1983, my objective was to provide superior and independent financial advice and to make enough money to support a family. As the business has grown, so have the objectives. They now include the following:

To be recognized as the leading provider of objective and coordinated financial advice in the region.

To enhance the quality of our service, by streamlining and systemizing our processes and procedures.

To build an organization that can handle the growing demand for our services, while balancing the career and personal lives of our employees.

To build an organization capable of serving multiple generations.

These objectives present significant challenges. In the course of moving ahead, you can expect that certain methods for implementing our service will change. I’m sure we will struggle at times as we attempt to move forward – just as we have over the last 23 years. We ask for your patience. Our principals will remain constant. We will always honor a fiduciary responsibility to keep the financial interests of our clients first – without hesitation. This is the cornerstone of our foundation of trust.

While the need for advice is growing, many consumers, unlike our clients, remain unable to differentiate between financial service firms. Who can blame them? Marketing prowess continues to mask the facts. For example, “advisors” in brokerage firms owe their primary allegiance to their employer – not their clients. You would never know that by their commercials. Even CPAs, considered among the most trustworthy of professionals, can receive commissions from selling financial products such as mutual funds, insurance and annuities. Some professional referrals are even tainted by strategic alliances with product sellers that split compensation with the referring professional. It’s still very much a “buyer beware” financial service market.

Our business will continue to be built one client at a time through referrals from clients and professionals appreciative of our level of commitment to excellence in service and objective advice.

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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