November 5, 2002

Dear Client:

Stocks had large losses across the board in the third quarter. The major stock indices declined between 17% and 22%, bringing the year-to-date losses for the S&P 500 to 28%. Other major stock indices have declined between 25% and 40% year-to-date. From the S&P 500's high on March 29, 2000 to its recent low on October 9, 2002 the market lost 47% of its value.

In comparison, the Crash of 1987 lopped "only" 29% off valuations over a three month period. The last period reminiscent of current economic conditions was 1973-1974. The Dow Jones Industrial Average peaked at 1051 in January 1973 then dropped 45% over the next two years to 577 in October 1974.

Battered investors are now reluctant to invest in stocks and some are even pulling money out of the stock market. As in 1973-1974, this is a period of great anxiety. Today's elections, conflict in the Middle East, terrorism, and a profound skepticism of our capitalistic system are causing fear and uncertainty. Here are some parallels between the early 1970's and now:

Even after the 47% decline of the last three years, stocks have returned 10% annualized since 1980. Is there reason to believe that stocks will perform differently in the future than they have in the past? Or to think that company owners (stockholders) will earn smaller returns than lenders (bondholders)? Perhaps the current state of the market is a rational response to the "irrational exuberance" of the last decade.

So what is an investor to do? Instead of making investment decisions from a predictive perspective, let's consider an alternate approach, where decisions are driven by individuals' capital needs. In this example John and Jane Doe are both 47 years old and have an investment portfolio of $1,600,000. They spend $90,000 a year in addition to their mortgage and expect to earn $150,000 per year in wages for the next 12 years.

In John and Jane's case a 1% increase in the annual investment return results in a difference of $1,900,000 in final portfolio assets. How is it possible that a 1% difference could have such a tremendous effect? A 7% portfolio needs to dip into principal sooner than the 8% portfolio, depleting working capital earlier, which in turn reduces future investment gains and accelerates the depletion.

The structure of the two portfolios is very different also. The 7% portfolio would be made up of an even split between stocks and bonds while the 8% portfolio would have a ratio of 3 to 1 stocks to bonds¹.

Finally, the capital needs approach takes into account the probability of achieving the expected return. The likelihood of achieving the 7% expected result is greater due to the lower volatility of bonds compared to stocks. A person's ability to tolerate risk is effected by both financial circumstances and temperament. In the capital needs approach risk management is a primary factor in the decision process.

This may be a good time to review your overall plan and understanding of the tradeoffs of risk and return.

Regards,

Audrey Grubman, CFP^®

P.S. Since the end of the third quarter the stock market has rebounded 12%. Let’s hope that the worst is behind us.

¹Assuming 10% stock return, 6% bond return, 1% investment fees, pre-tax annual return constant for 41 years.