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July 30, 2007

Dear Clients and Friends,

Second Quarter 2007 Financial Asset Performance

The Lehman Brothers Aggregate Bond Index was down 0.5%. The S&P 500 U.S. stock index was up 6.3%. Foreign equities, as represented by the MSCI EAFE Index, were up 6.4%.

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 Commentary

What is happening in the financial markets?

We have been in the midst of a global bull run that started early in 2003. Risk has been rewarded, and the riskier the better with commodity rich and developing economies at one end of the spectrum and low yielding AAA rated U.S. Treasury securities at the other. In hindsight, it looks so predictable. Combine easy global monetary policy, an abundance of cheap global labor, low interest rates and taxes, and the buy today, pay for it tomorrow U.S. motto (both the consumer and the government), and you get the perfect corporate profitability ingredient mix.

The riskiest U.S. loans (sub prime consumer debt and high yield corporate) had been trading at the narrowest of margins to U.S. treasuries. It is the exact opposite of what we saw back in 2001. Back then, high yield bonds were trading at 10+% above U.S. treasuries yields, as if high default rates from the worthless dotcom companies would continue indefinitely. A few weeks ago, the high yield market was priced so that average defaults would cause you to earn less than a risk-free treasury, assuming average historical default rates. Both periods represent extremes, which tend to happen during overly optimistic or pessimistic times.

Well, recently it seems as if tomorrow has arrived, and not all are prepared to make payment. Defaults and foreclosure are up significantly. Two hedge funds specializing in sub prime debt have recently gone under. Rating agencies are issuing a flurry of downgrades (albeit a little late), and creditors that were so eager to lend are now taking pause, and reassessing their lending requirements. To re-price this risk, yields on lower quality debt have recently jumped. At the end of June the high yield bond index was up over 2%, since then it has lost almost 4%.

The damage in the credit market has spilled over into the equity market. While corporations are still reporting strong profits, stock prices attempt to anticipate future, not current earnings. The continued slump in the housing market could lead to decreased consumer confidence and spending, negatively impacting corporate profitability as consumers account for approximately two-thirds of the U.S. economy. Higher rates and stricter lending standards will also slow down leveraging activity by hedge funds and private equity, which impact the price these entities are willing to pay to invest in or takeover public companies.

The Long Term Outlook

The global economy is surging, led by growth in emerging markets. The huge global labor force has also helped keep inflation at fairly benign levels over the last few years. As wages represent the single largest expense to corporations, the abundant supply of global labor has put a lid on wage price inflation. The world has become a more productive place with the successful integration of low cost outsourcing in combination with new technologies.

In addition, the rising middle class in third world nations has made the world less dependent on the American consumer. As wealth grows, citizens from emerging markets will demand goods and services from multinational U.S. and foreign firms that we in the developed world take for granted. It has been said by many that Americans under save, and to save more, we will have to consume less. The opposite is true for emerging market citizens, and their consumption will benefit corporate shareholders.



The Federal Reserve has two mandates. One is to control inflation and the other is to maintain full employment (i.e. low unemployment). Inflation generally spikes when demand is strong and the economy is growing at an above average pace. One of the key tools the Fed uses to discourage spending is to increase interest rates. The Fed basically trades lower growth and a potential increase in unemployment with the desire to keep the cost of goods from rising too fast. Conversely, the Fed reduces interest rates to soften the blow of slower growth to stave off a potential recession.

Although growth has been slowing in the U.S., commodity prices have increased from the production demands of emerging markets, causing inflation concerns at the Fed. This situation requires delicate maneuvering. Can the Fed risk lowering interest rates and risk higher inflation if the economy needs a boost?

Foreign Dollar Reserves

While the Fed controls short term interest rates, intermediate and long term rates are governed by the market. Currently the market is heavily influenced by Japan and China as they are the two largest buyers of U.S. debt. We discussed in the past how these two countries hold U.S. reserves as a way of keeping their products more competitive. If China or Japan decides that it will diversify its reserves into Euros or a basket of developed market currencies, intermediate and longer dated U.S. yields will be under pressure to rise.

Considering the above, how are we making investment allocations?

We will always maintain a core position in the two dominant global asset classes; equities, to benefit from global earnings growth and fixed income, to mitigate portfolio volatility. However, we are conscious of mitigating risks that pose a threat to both. The threat of inflation, and therefore a rising interest rate environment, in combination with low growth is one such risk. It is the reason we have added alternatives such as a long-short fund (Hussman Strategic Growth), a fund that focuses on real return assets (Pimco All Asset), and other positions that respond better than paper assets.

With respect to the sub prime and high yield woes, Loomis Sayles Bond Fund has captured the upside return of the high yield market, and not given it all back the last several weeks. Although we were a little early in removing our pure position in high yield corporate bonds, superior management at Loomis has ensured positive performance of this move from day one. We will continue to trust their tactical bond moves in efforts to boost return on fixed income assets.

We will continue to hold significant exposure to international stocks and maintain an emphasis on large capitalization U.S. stocks. Both have a more diversified customer base and help partially hedge the risks of a declining dollar. Holding more international exposure has gained momentum with many advisors as more recognize investor’s home country bias. Citizens hold more stocks from their home country than any other for no apparent reason than familiarity. We recognized this early on, and thankfully were rewarded by going against the mainstream allocation.

As the equity markets have continued to run, we have been getting some questions about the validity of our alternative additions. This reminds us of the late 1990’s when investors questioned the validity of their diversified bond holdings. Bonds eventually received their due as the stock market faltered in early 2000, and continued to suffer through the end of 2002. Unfortunately, it may take a tumultuous market for our more recent alternative additions to do the same.

Tax Wise Charitable Giving

We recently met with a representative of Fidelity’s Charitable Gift Fund. One of the important takeaways from the meeting was the use of the fund to maximize the tax advantages of using the fund for regular annual gifting, not just for major gifts.

Most of us are aware of the tax advantages of gifting appreciated securities, including mutual funds, to charities. Doing so provides the donor with a market value tax deduction, while the charity gets 100% of the tax free sale proceeds. We usually point out that it makes sense to consider this strategy when making gifts of a few thousand dollars.

The advantage of the Fidelity Charitable Gift Fund is that a donor can make a $5,000 contribution, get the immediate deduction and follow that up with instructions to Fidelity to make gifts as small as $100 to various charities. There is no requirement to provide directions to distribute the entire fund in any one year. Funds not distributed are invested and available for further distributions. You can add to the fund with as little as $1,000 at a time.

Fidelity’s charge for providing this charitable fund, handling the bookkeeping and making the distributions is 0.60% of the donor’s Gift Account. We think this charge is very reasonable.

Please visit Fidelity’s web site at http://www.charitablegift.org to learn more. If you would like to explore using this charitable gifting strategy, please call us for additional assistance.

Are You on Track? - The Accumulation and the Distribution Phases

There has been a significant increase in the number of articles in the financial planning press about Distribution Planning. This planning is concerned with strategies for taking distributions from investment accounts to support cash flow needs in retirement. Concerns include how much can be taken and when, along with which account (personal, trust, IRA), and in what degree should the funds be taken.

We can assure you that our firm places as much effort on getting the distribution phase right as we do the accumulation phase. While this may be a new area of emphasis for some advisors, it’s not for us. We are keenly aware of the income tax ramifications of taking distributions. We are also aware of contributions and withdrawals that clients make to the investment accounts we have access to. We attempt to notify clients in writing when we see savings levels lower than expected or withdrawal rates that are unsustainable.

We are working on a way to systematize an alert system that will give us a warning when clients in the accumulation (pre-retirement) phase are not saving enough to reach their goals. Likewise, we also want to know if clients in the distribution (retirement) phase are withdrawing at a rate consistent with their goals, financial security and potential longevity.

Until we determine how we will perform this review on a client-wide basis, we can perform a review now for any client that feels that their annual savings have been lower than estimated, or if their withdrawal rate has exceeded expectations in the Retirement section of your plan.

The Importance of Investment Diversification

We are disciples of investment diversification. Investment concentration, also known as putting all your eggs in one basket and watching the basket, is a way to build wealth - if you’re right. The way to keep wealth is through proper diversification. The enclosed article by Nick Murray eloquently states the case. Any time you are inclined to hold onto concentrated positions in any one stock, pull out this piece and read it.

Grown Up, but Not Gone

We have also enclosed a well written article about the retirement expense wild card of supporting adult children. We have witnessed a trend over the years of parent’s willingness to help out. The expenses related to this assistance are difficult to forecast and can disrupt the financial security of parents, if they are not careful.

If this, or any other, article is not applicable to you, please feel free to pass it along to family or friends that could find it useful.

Family Risk Management

Clients with grandchildren could find themselves with unplanned expenses if their adult children and son or daughter in laws neglect to secure adequate life and disability coverage. We understand that this may be a difficult subject to bring up, but unless this coverage is secured, your future financial security could be compromised. Do yourselves and your grandchildren a favor, ask your children about the extent of their disability and life insurance protection. If they have any questions about adequate coverage, have them contact us.

Office Move

We will be moving to newer and larger office space sometime in the next couple of weeks. As our suite gets closer to completion, we will have a better idea of the exact moving date, but our tentative date is August 10th. Our new address will be 2710 Centerville Road, Suite 201, Wilmington, DE 19808. The office is in a new building across from Little Falls Corporate Center, just south of the intersection of Route 48 and Centerville Road. Attached are directions for your reference. We have been told that we can keep our current phone and fax numbers.

Why are we moving? We currently have a million dollar view outside our office so this decision was not made without careful consideration. We could have moved into a larger suite in the same building or next door, but the addition of office space to our building will decrease available parking that is already at a premium. Our new office will have plenty of free parking. We do not want to take the chance that visiting clients would not have a safe place to park.

The new office will also provide a presence more in line with our position as a leading provider of wealth planning and investment advisory services.

New “Doing Business As” Name

In recognition of Ravi’s role as a principal and owner of the firm, we will coordinate the relocation of our office with a change in the “doing business as” name of the firm to Schiavi + Dattani. Over the next couple of months we will gradually transition to the new name.

Amit Suchak

Amit has been working part time with us during the last two years while taking a full course load toward his degree in accounting at the University of Delaware. Upon Amit’s recent graduation, he was offered and accepted a full time position with the firm. Amit brings a strong work ethic, a thirst for knowledge and a caring attitude, ingredients critical to successfully serving the needs of clients and being a valuable member of our team.

Amit will continue his work gathering accurate data for the production of quarterly reports and will work with us in increasing the efficiency of office operations, as well as special projects that arise in supporting the efforts of advisors serving clients. Please join us in welcoming Amit to the firm.

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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