A. Statistics
 

Details of the overall portfolio in 2006 are as follows:

Details of the individual years are as follows:

B. How has the portfolio performed during its life (1981- 2006)?

 Over the life of the portfolio it has performed in the following fashion:

              But, and this is an important but, the stability was NOT 10.9% p.a. each year for the entire 25 year period. The actual annual returns have been:
 
 

             We have also looked at the variability of monthly returns over the last 15 years and the data is presented below:
                 

 The largest monthly changes were: 

 

Largest annual increase (2003)	25.2%
Largest annual decline (1998)	-4.5%

 

a) Oddly, and unexpectedly, the worst year (1998) was far less damaging than I would have expected based on our methods of operation and based on the history of markets. I think you should plan for the next 25 years to include years that have larger negative annual returns although I would be surprised, but of course cannot guarantee, if the decline exceeded 10%. The probable existence of larger negative years in the next quarter century does not, in any way, change my positive prognosis for the portfolio and for our methodology.

b) The portfolio increased in value in 71% of the months measured and I think that we will find, when we gather the remaining data back to 1981, that the portfolio has increased in value about 75% of the time.

c) This means that, as a normal part of the process, the portfolio will decline in value between 25 – 30% of the time. Although this is a measure of the past 25 years I don’t see anything that would particularly change these ratios in the years ahead. This does not, incidentally, preclude a whole series of negative months. In fact, although most years had an overwhelming majority of positive months there were several years in the last decade where the negative months outnumbered the positive months (7 to 5 in each case).

           The Securities and Exchange Commission in their recent review reminded me that I should be careful in making “forward looking statements” i.e. comments about my expectations for the portfolio in the future. In the past I have always tried to be very careful in this regard by being circumspect in my statements. Here for their benefit is my standard disclaimer “Past performance is no guarantee of future successes”.

          The future offers no guarantees but we will use the same relatively risk averse methodology that has served us well over the last quarter century. I suspect the next 25 years will be difficult, perhaps much more difficult than many of us expect, and my goal is to achieve a rate of return that exceeds the ongoing rate of inflation by 5% p.a. (this is the base on which all our planning is built) and, more significantly to avoid major future financial disruptions.
 
              If you had invested $100,000 in the portfolio in 1981, it would have grown to $1,330,000 as of October 1, 2006 (without any further additions or withdrawals).

        The portfolio is structured in the following fashion and a glance at our previous reports will outline some of the dramatic changes that have occurred this year inside the portfolio. We started off the year with a lot of cash and this grew in size into the early spring when many markets experienced savage price declines. We committed a lot of funds to both domestic and international equities during that period at valuations that were attractive in both real and relative terms. In the aggregate they have performed well and, as you can see, our equity holdings are now at very low levels and our cash holdings are at record levels.

        Two things happened to cause the shift – the positive upward price movement in our holdings and the increasingly fragile state of the world economy as we navigate the post housing bubble period. As yet the bubble damage is barely visible but as the months pass it will ripple, or rumble, through the economy.
 
 

          In the last two years I have been increasingly concerned about the growing dangers that I perceive in the world economy. The highlights of my comments are:
 

a) The risks of economic dislocation appear to be higher than at any time in my long career, which spans four decades.
b) The potential resolutions to any of these “problems” (trade dislocations, housing bubbles, currency problems) also appear to have an unusually wide range of investment implications.

    There has been some excitement about the Dow Jones indices approaching their all time highs and the Wall street cheerleaders have been putting a positive spin on this but they seem to conveniently ignore the actual facts:
 

1. The index is close to where it was in 2000 but this means, at the very best, that investors in the Dow Jones 30 index have barely broken even over the last six years.
2. The much more representative S. and P. 500 index is well below it’s level of 2000 and the Nasdaq still needs to increase by over 100% to breakeven.
3. The average investor remains bloody and bowed by the debacle of 2000-3.
4. Stocks don’t seem overpriced unless you factor in the fact that profits as a % of Gross domestic product are at an all time high. This tends to be cyclical and profits of this magnitude have never persisted in the long run.
5. The risk of financial dislocation does not appear to be priced into this market. We may not experience dislocation, but I am not heavily investing our hard earned money unless we get adequately compensated for the risk we are incurring.

• The portfolio returns are unpredictable over shorter periods of time. We recognize that we cannot control price movements and we cannot control what will outperform in the next month or even the next year
• We expect a minority of our investments to be unsuccessful for a variety of fundamental reasons.
• We will have losing years. That is part of the process.
• We believe, but of course cannot guarantee, that we will attain our longer term goals for the portfolio.
• Our investment management is carefully, and individually, integrated with our financial planning on your behalf. We maintain a diversified portfolio.