Meeting the Needs and

Addressing the Financial

Goals of Private Investors

An Advertising Supplement to the

Meeting the Needs and

Addressing the Financial

Goals of Private Investors

2 Meeting the Needs and Addressing the Financial Goals of Private Investors CFA Society of Pittsburgh

April 6, 2007

Dear Business Times readers:

The CFA Society of Pittsburgh, in conjunction with the Pittsburgh Business Times, is proud to publish thisinvestment supplement, “Meeting the Needs and Addressing the Financial Goals of Private Investors.” Be-tween complex taxation issues and an ever-changing investment environment characterized by both un-certainty and opportunity, individual investors face a multitude of challenges in growing, protecting, andtransferring their wealth. In the following articles, written by members of the CFA Society of Pittsburgh,we have tapped their expertise on topics including advisor selection, individual security selection and port-folio construction, commodities and hedge funds, and retirement strategies.

Celebrating its 50th anniversary in 2007, The CFA Society of Pittsburgh is the local society of the CFA In-stitute. The CFA Institute is the issuer of the CFA Charter and has 77,000 charterholder members global-ly. Its mission is: “To lead the investment profession globally by setting the highest standards of ethics, ed-ucation and professional excellence.” The Pittsburgh Society has approximately 400 local members, whowork in the investment industry as portfolio managers, security analysts, investment advisors, and otherfinancial professionals.

The Economist ranked the Chartered Financial Analyst (“CFA”) Program as the gold standard among in-vestment analysis designations. CFA Charterholders successfully complete three levels of demanding ex-aminations, proving extensive knowledge of financial analysis and portfolio management. Charterholdersmust also maintain a commitment to the Code of Ethics and Standards of Professional Conduct, which de-mands that, above all else, the interests of the client come first.

On behalf of the CFA Society of Pittsburgh, its members and its leadership, I hope that you enjoy the sup-plement. Please visit our web site at www.membersocieties.org/pittsburgh, or contact one of the boardmembers below should you have any questions.

Sincerely,

Michael P. Hrycenko, CFAPresidentCFA Society of Pittsburgh

Michael P. Hrycenko, CFAPresident

(412) 768-1032PNC Wealth Management

Robert A. McGee, CFAVice President - Education

(412) 880-5234CS McKee

Michael K. Kauffelt, CFASecretary – Membership

(412) 801-4900Bill Few & Associates

Todd F. Rongaus, CFATreasurer

(412) 762-7295PNC Capital Markets

Erich C. Smith, CFA(412) 234-5033

Mellon Financial Corp.

Kevin R. McCloskey, CFAProgram Chair(412) 288-6508

Federated Investors

Kathleen S. Wright, CFA(412) 854-2100

Wright Associates

Phillip L. Baird, III, Ph. D., CFAUniversity Outreach Chair

(412) 396-4735Duquesne University

CFA Society of Pittsburgh Meeting the Needs and Addressing the Financial Goals of Private Investors 3

By Don Belt, CFA &

Brian Koble, CFA

Dividend growth is a powerful themethat is often overlooked by investorsseeking income, particularly today whencurrent dividend yields are near historiclows. Dividend payouts have historicallygrown at a meaningful rate, however,and rising dividends can help investorsto grow their income streams and toprotect against rising costs of living.Capturing dividend growth is especiallyimportant today as rates on long-termfixed-income investments are in somecases unsatisfying.

Income-seeking investors typicallypay the most attention to the “currentyield” of their investments, which is theamount of the distribution as a percent-age of the investment’s current marketvalue. On this basis, the broader stockmarket as represented by the S&P 500has a current yield of approximately1.8%. Because stock price appreciationhas historically outpaced dividendgrowth, stocks’ current yield has fallenover time, from over 6% in the early1980’s.

Another way to think about yourincome stream is as “yield on initialinvestment”, or the amount of the cur-rent distribution as a percentage of theinitial investment amount. For investorswith long time horizons, the currentyield and yield on initial investment canvary greatly. Consider a $10,000 invest-ment in the S&P 500 with a current yieldof 1.8%, or $180. After 20 years, assum-ing the index’s historic dividend growthrate of 5.9% per year, the income fromthe position would have grown to $530,or a 5.3% yield on the initial investment.Assuming a growth rate of 10%, consis-tent with some areas of the markets, theincome stream would have grown toapproximately $1100, or an 11% yield oninitial investment. At the same time, thevalue of the stock position is likely tohave risen considerably. We believe thiscombination of growing capital andincome makes dividend growth a neces-sary component for investors planning

for future income needs.The benefits of dividend growth go

beyond rising income streams, howev-er. Stocks that grow their dividendshave historically outperformed stocksthat pay stable dividends and especiallystocks that do not pay dividends. Thismakes intuitive sense since dividendgrowth is often an indicator of strongcorporate fundamentals. According toNed Davis Research, S&P 500 compo-nent stocks that grew or initiated divi-dends over 12 month periods from 1972until present grew at an 11% annualrate. By comparison, stocks with con-stant dividends grew at a 7.2% rate,while stocks that paid no dividendsgrew at a 2.4% rate. Part of the reasonfor the relatively strong performance ofdivided-growers is their downside pro-tection during bear markets. Duringperiods of market tumult, investorstend to gravitate toward safer compa-nies with sound operating fundamen-tals.

Where can investors gain access todividend growth? An important con-sideration is that high current yielddoes not necessarily indicate futuredividend growth. Companies that payout a very high percentage of theirearnings as dividends are not reinvest-ing significantly in their business, thusinhibiting future growth potential. Thesearch is also complicated by recentdividend tax reforms that exclude someareas of the markets.

For most investors, the best option isto invest with a professional moneymanager that specializes in dividendgrowth stocks. Through products suchas mutual funds, a manager can offerexpertise, instant diversification, andfar greater investment resources thanare available to the individual investor.Within the context of a well balancedportfolio spanning multiple asset class-es and sectors, dividend growth orient-ed funds can play an indispensable rolein the quest for growing capital andincome.

Don Belt, CFA is the Chief Investment Of-ficer and Brian Koble, CFA is the ResearchAnalyst for Hefren-Tilotson, Inc. of Pittsburgh.

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4 Meeting the Needs and Addressing the Financial Goals of Private Investors CFA Society of Pittsburgh

By Linda A. Duessel, CFA

When it comes to managing retirementportfolios, some of the most commonmistakes and missed opportunities tendto be age-specific. Here’s our short list:Age 40 and younger: Time is on yourside. Use it.

• Common mistake: Being too con-servative. Astute as many younger in-vestors are, we meet a surprising numberwho are far too conservative. The 40-and-under crowd should remember that, withincomes likely to rise and plenty of timeto recover from a loss, time is on theirside. Under the circumstances, a pro-nounced tilt toward stocks seems in or-der. Stocks are riskier than bonds, becausetheir prices are more volatile. But, overtime, stocks have outperformed bonds.

• Common Opportunity: Interna-tional investing. If economists’ expecta-tions play out, such investment destina-tions as China, India and much of the for-mer Soviet Bloc will be the growth storiesof the next few decades. Meanwhile, de-spite some growing pains, “Old Europe”is making progress toward a unified econ-omy, and Japan appears to be on the growagain. Ages 41-55: Making up for lost time.

• Common mistake: Expecting some-one else to take care of you. As a group,baby boomers have tended to spend mostof what they’ve earned, and often more.What does that leave for retirement? Theaverage Social Security payment is justunder $11,000 per year, according to a re-port by the Century Foundation. Inheri-tance? Among boomer households thathave inherited money, the average “wind-fall” was $64,000 in today’s dollars -- hard-ly enough to provide an income supple-ment that may have to last for several

decades. Boomers need to save a lot more.Starting yesterday.

• Common Opportunity: Peak earn-ing years. Typically, ages 41-55 are peakearning years. Incomes still are rising, andin many cases the expenses of raising afamily and paying for children’s educationare gone or diminished. This is the timeto fight inertia and start saving, or startsaving more. Ages 56-70: You’ve made it. Now keepit. And keep it growing.

• Common mistake: Failing to strikethe right balance. This age group needsa portfolio consisting of both stocks forgrowth and bonds for income. As a ruleof thumb, and depending on risk toler-ance, those with a 10-year horizon to re-tirement might consider an allocation of60% stocks and 40% bonds, incremental-ly moving to a 40%/60% as retirement isimminent.

• Common Opportunity: Putting thebalance on auto-pilot. For the reasonswe’ve outlined, especially at these ages,asset mix is critical. Fortunately, in recentyears a number of financial products havecome to market that automatically re-balance and allocate based on an in-vestor’s time horizon.

We’ve focused here on what “age-ap-propriate” investing might look like. Butthere is one hugely important relatedcaveat: An investor’s personal risk toler-ance is the key. Some strategies carrymore risk than others, and individual risktolerance varies. Before implementing anystrategy, an investor should fully under-stand the risks, and make certain he orshe is comfortable with them.

Linda A. Duessel, CFA, Senior Vice Pres-ident, Senior Portfolio Manager/Equity Mar-ket Strategist, Federated Investors, Inc.

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6 Meeting the Needs and Addressing the Financial Goals of Private Investors CFA Society of Pittsburgh

By John D. Culbertson, CFA

If you are looking for an investmentexpert, I would like to give you some rea-sons to choose an individual with “CFA”after the name on their business card. Iam recommending this because I am aCFA, having achieved this honored des-ignation in 1979. I am also a retired CFA,so I’ve been around the block a fewtimes. I worked in Pittsburgh for 35years, managing portfolios for individu-als and charitable institutions. I haveserved as President of the PittsburghCFA Society, I have graded CFA exams,and I recently put in a six year term onthe Disciplinary Review Committee ofthe CFA Institute.

This experience gives me someauthority to answer two questions thatyou should be asking yourself about yourfinancial advisors. Are they well trained?

Those in the business know that theCFA examination process is one of themost grueling and rigorous of any disci-pline. Currently, there are 68,000 CFACharter holders worldwide. In 2006, over100,000 candidates sat for an exam at186 test centers in 86 countries. Of these,fewer than 20% will eventually earn a

CFA Charter. The recommended studytime to prepare for each exam is 300-350hoursGlobal Pass Rates for each exam in 2005Level I 36%Level II 56%Level III 55%

Largest test centers in order of sizeare: New York City, Hong Kong, andToronto

Requirements for a CFA:

Bachelors DegreePassage of three sequentialsix hour examsWork in the profession for four years. Commit to and abide by the CFA Codeof Ethics and Standards of ProfessionalConduct

Can their advice be trusted?

Any person familiar with how marketswork will tell you that no one can predictexactly how investments will perform.Therefore, what the consumer of invest-ment advice should be searching for isan individual who will give a rationaland fair assessment of their choices, anda reasonable balance given the possibleoutcomes. More to the point, the con-sumer will want to know that their advi-sor’s compensation is transparent. TheCFA Charter carries with it a require-ment to follow the very specific provi-sions of the CFA Code of Ethics andStandards of Professional Conduct.Violation of these rules can and haveresulted in suspension from the CFAInstitute and loss of the CFA designa-tion. Independence and objectivity arecentral to the code. (You can see theactual hearing outcomes onhttps://www.cfainstitute.org/aboutus/conduct/pdf/mem_discipline_stats.pdf. )These are real requirements that havereal consequences for practitioners.

In a world where information is over-whelming and “experts” are everywhere,The CFA Charter is a very good indicatorthat the individual who has earned it isknowledgeable, seasoned, and fair.

The Chartered Financial Analyst Represents

Highly Committed Professionalism

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CFA Society of Pittsburgh Meeting the Needs and Addressing the Financial Goals of Private Investors 7

By Douglas Kreps, CFA

The grass is always greener on the other side of thefence. Growing up, we all heard this axiom from ourparents and grandparents when we thought some otherchild had things better than we did. But while mostadults remember this lesson when their neighbor gets ashiny new car, when it comes to investment decisions,people still fall into the “grass is greener” trap.

Back in the late 1990s, this envy was felt by those whobelieved in fundamental valuation techniques to valuestocks. Despite an inner voice that was yelling NO, peo-ple fell into the technology stock trap, and many lost asignificant amount of money. From a distance, it lookedlike a friend or neighbor’s portfolio was greener (punintended), and as a result many people sold solid but rel-atively underperforming stocks and loaded upon Cisco,Nortel, and the like. But once they were in the suppos-edly greener pasture, they soon found that it was actual-ly a rocky place to sow investment seeds, and endured abear market lasting through 2002.

Despite the recent downturn, and much media hypeabout sub-prime credit concerns, we find ourselves in amarket not down far from its all-time highs as measuredby the Standard and Poor’s 500 Index. But given thequestions we hear from prospective clients, the grass isgreener lesson still has not sunk in. This time it is nottech stocks, but rather the siren call of hedge funds, andto a lesser extent private equity funds. While we cannotpredict for certain, it is likely that this latest trend willend badly for investors as well.

Hedge funds’ original purpose was doing exactly whatthe name implies: hedge risk. The manager of the fundwould have a specific mandate, say selling stock short,and the goal was to reduce the overall volatility of aninvestor’s portfolio without compromising potentialreturn. Then more exotic strategies appeared, perhapsmost famously George Soros’ Quantum fund, whichengaged in global macro trading bets. Since then, wehave seen an explosion in hedge fund strategies, withendless varieties of risk and return objectives.

The original hedge funds carried with them very highinvestment minimums, often exceeding $5 million, andas a result were only available to “sophisticated” or atleast “accredited” investors. They provided liquidity tothe markets, and with the exception of some famousblow-ups like Long Term Capital in 1998, served a usefultool for the diversification of very large portfolios, likepension funds and endowments. But never one to missan opportunity, Wall Street began to create productscalled funds of funds. In a fund of fund structure, a largepool of capital would be raised from smaller investors,say $100,000 each, and then invested across a number of

different hedge funds. What does this trend mean for the average investor? A

couple of things. First, hedge funds are very expensivefor investors, and when calculating performance, feesare important to consider. Annual fees may be 2%, andthe manager may keep 20% of the fund’s gains. If you aretalking about a fund of funds, expect another 1% on topof the underlying hedge fund expense. Three percentannually is a lot to pay for somebody to manage a port-folio.

Perhaps more important, a second portfolio manage-ment axiom is that “bad money drives out good.”According to a July 31, 2006, Fortune story on the sub-ject, there are now more hedge funds (8,000+) than thereare Taco Bells (6,010). Witnessing how difficult it is tofind employees who can competently fill the jobs atTaco Bell, is it really possible that there are over 8,000individuals gifted enough to beat the market? I doubt it.

Without question, there are still some hedge fundswhich are doing very well for their partners. But manyof the established funds with solid histories are closed tonew investors, and others have been returning capital asthey have been unable to find enough attractive invest-ment opportunities. It is difficult for us to be excitedabout future returns from hedge funds in an increasing-ly crowded marketplace. While it may seem greener aswe peer over the fence, investors should watch out forthe rocks hidden in the tall grass.

Douglas Kreps, CFA is a Principal and ManagingDirector for Fort Pitt Capital Group, Inc.

How Not to Hedge your Risk

By Bill Stone, CFA

For those of you who may have ignored the Roth IRAbecause your income has excluded you from eligibility,take note: Starting in 2010, current income limits will, ineffect, be eliminated.

In essence, a new tax law passed in 2006 allowsinvestors to make contributions to a Roth IRA via a two-step process: first, by making contributions to a nonde-ductible IRA for the next few years and, second, by con-verting to a Roth IRA in 2010.

Many high-income investors will want to take advan-tage of the new Roth IRA conversion rule for several rea-sons:

• Tax-free distributions. Although contributions toRoth IRAs are made with after-tax dollars, qualifyingwithdrawals are exempt from income tax. Withdrawalsfrom traditional IRAs are fully taxable at then-currentrates.

• No required minimum withdrawals. Unlike tradi-tional IRAs, Roth IRAs do not require account holdersto take distributions during their lifetime. This provi-sion allows individuals with sufficient wealth to passRoth IRA monies to beneficiaries who can go on to ben-efit from tax-free distributions over their lifetimes.

• Gain immunity from future tax increases. Becauseno taxes are owed on Roth IRA distributions, those whoperform a conversion will be immune to any future taxincreases.

The following example illustrates how making annu-al contributions to a nondeductible IRA now canamount to significant tax-free wealth for future genera-tions.

The Roth IRA Advantage — One Couple’s Story

Consider, for instance, a husband and wife who begincontributing to a nondeductible IRA in tax year 2006.Because they are both age 55, they are allowed to con-tribute $10,000 a year ($5,000 each) in 2006 and 2007.This amount will rise to $12,000 in 2008. In 2010, thecouple can convert the assets to a Roth IRA, paying taxonly on the investment gains earned thus far. From thispoint forward, the assets will grow tax free under theRoth IRA umbrella (see Exhibit A).

Now assume the $61,616 converted to a Roth IRA in2010 grows at an annual rate of 8% for 30 years. No newmoney is added to the account, as the couple’s incomeexceeds the $160,000 contribution limit, but no moneyis withdrawn from the account either. Upon theirdeaths at age 90 in 2041, the Roth IRA, now worth morethan $600,000, passes to the couple’s 60-year-old son.

Passing the Legacy

For the next 25 years, the Roth IRA continues to growat an 8% annual rate of return, and each year the sontakes tax-free distributions from the account. By 2065,what started as a $56,000 investment in 2010 has pro-vided more than $2 million in tax-free distributions —or the equivalent of $442,390 in today’s dollars, adjustedfor 3% inflation (see Exhibit B).

As with any tax law, there is a chance that Congresscould reverse its decision to make Roth IRA conversionsavailable to all, regardless of income level. If that wereto occur, high-income investors may still want to takeadvantage of the tax-deferred growth potential of anondeductible IRA.

To learn more about how an IRA could enhance your

financial plans, speak with your PNC WealthManagement advisor.

The example is hypothetical and presented for educa-tional purposes only. Investment returns and inflationrate cannot be guaranteed. Actual results will vary.

Exhibit A: Nondeductible IRA Contributions, 2006-2010 (married couple, age 55, 5% annual rate of return)

Beginning EndingYear Balance Contributions Earnings Balance2006 $0 $10,000 $500 $10,5002007 $10,500 $10,000 $1,025 $21,5252008 $21,525 $12,000 $1,676 $35,2012009 $35,201 $12,000 $2,360 $49,5612010 $49,561 $12,000 $3,078 $64,639

$56,000Taxes Owed on Conversion (@ 35%) $3,024Converted After-Tax Amount $61,616

Exhibit B: Cumulative Distributions, 2041-2065 (8% annual rate of return, distributions taken annually)

Bill Stone, CFA is a Senior Vice President, for PNC Wealth Management.

Contribute Today, Convert Tomorrow:

The New Value of Nondeductible IRAs

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