January 16, 2004

Dear Client:

Many investors now have a better understanding of both components of investment performance: risk and return. The objective of portfolio management is not solely to earn the highest return, it must be to earn the highest return at an appropriate level of risk.

In earlier letters we have talked about risk in terms of volatility of returns. A determining factor of portfolio volatility is the correlation of the securities in your portfolio. A positive correlation means that securities move in the same direction at the same time. A negative correlation means they move in opposite directions at the same time.

As an example, let’s look at just two stocks, Coke and Pepsi. Let’s assume that everyone in the world drinks only soda, and Coke and Pepsi are the only choices. Whenever Coke's stock increased, Pepsi stock would decrease. Coke and Pepsi would then have a perfect negative correlation.

Both earn an average return of 10% over a ten-year period, but the returns fluctuate from -5% to 25% each year. These two stocks would be negatively correlated: i.e., when Coke gains 25%, Pepsi loses 5%, and when Pepsi moves +25%, Coke moves -5%.

If you owned either stock, at the end of ten years you would have earned 10% per year, but that return would have fluctuated dramatically. If you owned both stocks, at the end of the ten years you would have the same 10% annual return, but without any fluctuation whatsoever.

It is impossible to design a 100% negatively correlated portfolio, but you can significantly reduce the volatility of a portfolio by applying correlation principals to your investments. The reason for owning stocks and bonds is that they are negatively correlated: when stocks increase, bonds decrease.

U.S. and foreign stock markets were traditionally considered to have a negative correlation. In recent years it appears that the correlation has increased, i.e., both seem to move in the same direction at the same time. But even if the markets move in the same direction, currencies move in opposite directions, and your portfolio's risk will be reduced by investing in U.S. and foreign currencies simultaneously.

Over the last year the U.S. dollar has declined compared to the European euro and the Japanese yen. An investor who bought €10,000 (euros) worth of foreign stocks on January 1, 2003 would have €11,744 on December 31, 2003. A U.S. investor who bought $10,000 of the same stocks on the same day would own $13,860 worth of stock on December 31, 2003.

Understanding and predicting short-term currency and interest rates is the life's work of many intelligent people, and I don't profess to be able to foretell what will happen in 2004. But it is safe to say that owning stocks denominated in several currencies will make your portfolio less risky than one that is invested only in U.S. securities.

Mutual fund scandals continue to unfold. The SEC announced yesterday that it is investigating compensation made to mutual fund brokers in return for pushing the funds' products. This follows last year's investigations of market timing and late trading arrangements between mutual fund companies and their preferred investors. We expect the next investigation will be of "soft-dollar" arrangements, whereby a broker provides research and other benefits to certain customers in return for receiving their trading commission business.

Even the so-called "independent" brokers, such as Schwab, receive soft-dollar services from mutual fund companies. Even the money managers recommended by Schwab through their "Advisor Network" pay a significant ongoing commission to Schwab for the referrals.

We do not receive any fees or benefit from your business other the management fee we charge. The larger your portfolio, the greater our revenue, so it is in our mutual interest to minimize your costs and maximize returns. We have no allegiance to any fund company or broker. We are on your side: we make money when you do.

A few fund companies paid dividends on December 31, 2003 that were not included in Fidelity's December statements. Those dividends will get reported on the January 2004 brokerage statements, with an "as of date" of December 31, 2003. Your enclosed statement includes the January-reported dividends, as will your 2003 Forms 1099 from Fidelity. The funds which reported late are from Vanguard, American Century, and Asset Management fund companies.

Regards,

Audrey Grubman, CFP^®