2006-2007 Model Portfolios Update

Our model portfolios are constructed using a simulation optimization methodology. They assume that an investor understands the long-term compound real rate of return he or she needs to earn on his or her portfolio to achieve his or her long-term financial goals. We use SO to develop multi-period asset allocation solutions that are “robust”. They are intended to maximize the probability of achieving an investor's compound annual return target under a wide range of possible future asset class return scenarios. More information about the SO methodology is available on our website. Using this approach, we produce model portfolios for six different compound annual real return targets: 7%, 6%, 5%, 4%, 3%, and 2% We produce two sets of these portfolios: one assumes only investments in broad asset class index funds. These are our “all beta” portfolios. The second set of model portfolios includes equity market neutral (uncorrelated alpha) funds as a possible investment. These assume that an investor is primarily investing in index funds, but is willing to allocate up to ten percent of his or her portfolio to equity market neutral investments.

We use two benchmarks to measure the performance of our model portfolios. The first is cash, which we define as the yield on a one year government security purchased on the last trading day of the previous year. For 2006, our U.S. cash benchmark is 4.40% (in nominal terms). The second benchmark we use is a portfolio equally allocated between the ten asset classes we use (it does not include equity market neutral). This portfolio assumes that an investor believes it is not possible to forecast the risk or return of any asset class. While we disagree with that assumption, it is an intellectually honest benchmark for our model portfolios' results.

Mutual and exchange traded funds that can be used to implement these model portfolios' asset allocations are listed on our website.

| Global Asset Class Returns | 2006-2007 Model Portfolios Update | A Note from the Publisher | Equity Market Valuation Update | This Month's Letters to the Editor:Volatility (Difference Between Futures Contracts and Realized Volatility) and How to Position Portfolios Under Different Crisis Situations | Product and Strategy Notes: Another Look at Avian Flu, Mervyn King's Speech (Governor Bank of England), New US Commodity ETF (DBC) and and Yale/Harvard | This Month's Issue: Key Points | Forecasting |