January 2006: Overview of 2005 - Review of Our Investment Strategy

AN OVERVIEW OF 2005

In a year that offered limited opportunities, we are very satisfied with the outcome our portfolios achieved in 2005, especially in light of the unimpressive returns in the stock and bond markets. Money market fund returns surpassed the Dow Jones Industrials (+1.7%) and NASDAQ (+1.4%) last year. The Standard & Poor’s 500 fared somewhat better returning +4.9% including reinvested dividends. For bonds, the Lehman Brothers Aggregate Bond Index was up only 2.4% for the year.

The average balanced mutual fund with 50-70% in stocks outperformed these popular indexes with a +5.2% gain for the year. Even better, Asset Allocation Advisors' clients topped that mark by an additional 2% with an average return of +7.2% for the year.

Your results were among the best possible (please see Investment Performance Disclosures). Although no assurances can be made concerning future investment results, and past performance does not guarantee future performance, we believe that the portfolios we have constructed for our clients are logical candidates to continue to exceed the average results of comparable balanced mutual funds in 2006 and beyond.

"The benefits of our investment strategy shine in a flat or low return market like 2005 because the abilities of good fund managers are most evident in this type of environment."

A REVIEW OF OUR INVESTMENT STATEGY

Our investment strategy is designed to pursue two objectives — profits and protection of capital. There are three fundamental premises to our strategy:

1. Balanced Investing: We believe, and history has shown, that a balanced approach to investing — that employs a diversified mix of stocks, bonds and cash — is the best long-term path for safety-minded investors wishing to accumulate and protect their capital.

2. Exceptional Managers: There are a handful of exceptional balanced mutual fund managers that have outperformed their peers for multi-year periods, spanning periods of adversity and prosperity, and both up and down markets.

3. Selecting the Best: Identifying and using these exceptional balanced mutual funds (the "best of the best") should result in superior results over the long term by enhancing investment returns and the protection of capital.

Our initial job is to screen and identify the best fund managers with objectives similar to our own. Upon making our selections, we take the actions needed to establish your portfolio. Thereafter, we review and monitor each of your holdings to make sure our selections remain on track to accomplish our goals of profits and protection of capital.

Good investing doesn't need to be exotic, exciting or complicated. It just needs to get the job done.

Carefully selected portfolios of 8-12 mutual funds, compared to just three or four funds, offer additional layers of diversification and capital stability that can further reduce the influence of random events in the marketplace and the occasional "off year" that even the best fund managers may experience from time to time. Furthermore, our process also incorporates the way funds chosen for your portfolio work in combination with each other as much as for the individual attributes of each fund. These attributes are helpful in achieving a favorable "risk-reward" tradeoff (returns disproportionately high relative to the level of risk incurred).

The benefits of our investment strategy shine in a flat or low return market like 2005 because the abilities of good fund managers are most evident in this type of environment. Many funds look good when the stock market is going straight up, but it takes skill to do well when the opportunities are meager, as they were in 2005. We believe the funds we have selected for our clients are navigated by some of the most skilled and talented balanced fund managers in the business. They have shown themselves to be adept at identifying and capitalizing on opportunities when and wherever they avail themselves. The performance advantage these funds provided again in 2005 is a demonstration of the effectiveness and value of this strategy.

It is interesting to note that even though our clients attained a clear performance advantage for the year, they underperformed our benchmark half the time! In two of four quarters, we trailed our benchmark yet still surpassed the benchmark by 2% for the full year. Here's how it came out:

The point? A solid investment strategy that relies on balance, diversification, moderation and patience (like our strategy) can get the job done and provide superior performance without being the best each and every quarter. Successful investors don't need superior returns every month or every quarter. And, it is not necessary to have the "hottest" investments, nor is it necessary to do a lot of buying and selling. Good investing doesn't need to be exotic, exciting or complicated. It just needs to get the job done.

WHAT’S AHEAD FOR 2006?

Neither we nor anyone else can accurately predict the future. It’s simply not possible. Of course, that won't stop the media from soliciting "expert" predictions about the coming year. And some of those prognostications may even be correct. (Even a blind pig finds an occasional kernel of corn.)

Fortunately, it isn’t necessary for us to do the impossible and foretell the future. With the portfolios we have constructed, we believe we are in good shape to handle whatever the coming year may bring because your and our portfolios are guided by an investment strategy based on research, logic and history. We are optimistic that your portfolio (and our company pension plan) are well positioned to weather and take advantage of whatever comes our way. ***

Greg Schultz & Bruce Grenke
© 2006 Asset Allocation Advisors, Inc.