F W S Fa b ian W e a l th S trat e g i e s

The Ultimate Income Strategy Special Report By Doug Fabian, President, Fabian Wealth Strategies February 2012

“You have to make your money work for you.” We’ve all heard this adage, and to be certain, it is the key to income investing success. And while the truth of this statement can’t be argued, it’s definitely a lot easier to say than to actually do. At Fabian Wealth Strategies, we take the concept of making your money work for you very seriously. But what does it actually mean to have your money working for you, and how can we help you achieve that noble goal? Answering these questions is what this report is all about. Our firm specializes in helping clients preserve their investment capital while also generating the income they need to live the life they desire. However, conventional Wall Street wisdom usually pits the twin objectives of capital preservation and high income generation at odds. According to the official party line, you can either A) preserve capital by sticking your money in “safe” investments that offer a pitifully low yield, or B) put your money at risk in dividend stocks and other high-yield equities and be willing to wait out the inevitable market declines that are inherent in these kinds of securities. Well, we think this conventional wisdom is flawed, and we know there’s a better way to manage your income assets. You see, instead of the either-or choice of safety vs. yield, we’ve developed a strategy designed to maximize income while at the same time managing the various risks inherent whenever you put money to work in the market. We call it our “Ultimate Income Strategy,” and when you’re finished reading this report, you should have a good sense of how the strategy works, and more importantly, how it allows your money to work for you.

The 3 Legs of the Strategy The Ultimate Income Strategy can best be described as an approach to investing that uses a variety of investment tools in conjunction with a proven trend-following methodology developed over three decades ago, and that continues to be refined to this day. The overarching tactic used in the Ultimate Income Strategy is to move money in and out of a combination of what we call the “3 legs” of the strategy, which are 1) dividend paying equities, 2) fixed-income and 3) alternative income investments. When conditions are conducive to each respective asset class, we get our money exposed to that class. Conversely, we move money out of these respective sectors as soon as we determine conditions have become unfavorable. At Fabian Wealth Strategies, we take advantage of these various asset classes by purchasing exchange-traded funds, also known as ETFs. The ETFs we use offer very low expense ratios, and are objectively managed, which means we know exactly what each fund owns at any moment. Because ETFs are traded on an exchange just like stocks, they are the ultimate in flexible investment instruments. This flexibility is important, as the Ultimate Income Strategy requires the ability to move in and out of particular sectors as soon as we think conditions warrant such a move. Another critical component of the Ultimate Income Strategy is to have both minimum and maximum exposure limits in any one asset class. The diversification of having a portion of an income portfolio in equity funds, bond funds and alternative funds, virtually at all times, allows our portfolio to nearly always be generating income regardless of prevailing market winds. Our actively managed income-generating strategy also allows us to fine-tune our asset allocation mix so that it can take full advantage of whatever the market throws our way. Part of the active management in our Ultimate Income Strategy is the use of macro themes to select areas of the market we believe will perform well over the long term. The overriding objective in the Ultimate Income Strategy is to generate a robust income stream while also maintaining an attractive yield regardless of the climate in the financial markets.

Building the Ultimate Income Portfolio The process of building the Ultimate Income Portfolio requires that we be keenly aware of myriad conditions affecting nearly every aspect of the financial markets. This awareness and understanding has been garnered through years of experience in the trenches helping investors preserve capital and generate income. This same experience has taught us how to shift our income portfolio allocations so that they are in the best position to perform well. The first step in building our Ultimate Income Portfolio is to determine our position size in

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dividend-paying equity funds. Here we are talking about ETFs that hold stocks known to pay solid dividends. A position size of between 10% and 40% of our overall income portfolio is used, with the size of that allocation based on current market conditions. For example, we may have only a 10% allocation to dividend-paying equities during a bear market, as the general climate here would be pushing the value of dividend equities lower. Conversely, if stocks are in a bull market, we may maximize our allocation to dividend-paying equity funds by putting up to 40% of the portfolio in these assets. One key to determining how much of our income portfolio is

Dividend Equity Funds Ticker DVY HDV IXP XLU DWX DEM DLN

Name iShares Dow Jones Select Dividend Index iShares High Dividend Equity Fund iShares S&P Global Telecommunications Utilities Select Sector SPDR SPDR S&P International Dividend WisdomTree Emerging Markets High Yield WisdomTree Emerging Markets High Yield

devoted to dividend-paying equities has to do with where the Yield%

overall market is relative to its long-term moving average. Here we

3.30

rely on the 200-day moving average. If stocks currently trade above

2.66

their 200-day average, conditions are bullish and therefore merit a higher dividend-equity allocation. If, however, stocks trade below

4.69

their long-term moving average, then conditions are bearish, and

4.31

that merits a lower level of dividend-equity exposure.

4.03

The Dividend Equity Funds table lists just some of the dividend-

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paying equity ETFs we use in the Ultimate Income Strategy. These dividend-paying equity ETFs give you excellent potential for

3.20

both capital appreciation and current income. And while they are great tools for helping you achieve these dual goals, they cannot

*Yield data as of 12/31/11

be bought without regard to risk. That’s why we monitor all of our income positions, and why we actively size them according to market conditions. One of the best funds on the list here is the iShares High Dividend Equity Fund (HDV). This is one of the newest ETFs to come out with an equity dividend focus. Making its debut in March, 2011, HDV has become one of our favorite ways to gain exposure to some of the biggest and strongest dividend-paying companies out there. To give you a sense of what kind of companies we’re talking about, HDV counts among its top holdings stalwart dividend giants such as telecommunications firm AT&T, oil behemoth ConocoPhillips and healthcare products giant Kimberly-Clark. When you own HDV, you essentially own 75 stocks in the Morningstar Dividend Yield Focus Index. These are some of the oldest, largest and most established businesses in America, businesses with long and brilliant track records of paying dividends to shareholders year in and year out. This ETF pays its dividend quarterly, so every three months you can ring the register with the income you get from this holding. During a slow-growth environment, investors tend to flock to companies with a steady hand, and that keep earning money despite difficult economic conditions. In other words, the companies contained in HDV.

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Cash, 5%

Bull Market Allocations In a bull market, you generally want to

Dividend Equities 40%

have more dividend-equity exposure than at any other time. The chart here shows

Alt Investments 25% Fixed Income 30%

what our Ultimate Income Portfolio would look like in a bull market.

The second step in building our Ultimate Income Portfolio is determining our fixed-income, or bond, exposure. Here we seek a position size in the range of 20% to 60% of our overall portfolio. The current environment in the bond market, i.e. interest rates, helps determine the extent of our fixedincome allocation. In addition to the overall trend in the bond market, part of the Ultimate Income Strategy diversifies the type of bond funds we will own. For example, at times we may combine a bond fund with extremely low credit risk with bonds that have higher credit risk but that pay higher yields. It’s a blend of quality and yield that we seek to achieve with our fixed-income exposure and that helps offset the risk inherent when investing in bonds. The Fixed-Income Funds table lists some of the fixed-income bond

Fixed-Income Funds Ticker IEF TLT TIP AGG MBB LQD HYG CIU EMB

Name iShares Lehman 7-10 Year Treasury Bond iShares Lehman 20+ Year Treas Bond iShares Lehman TIPS Bond iShares Lehman Aggregate Bond iShares Lehman MBS FixedRate Bond Fund iShares iBoxx Investment Grade Bond iShares iBoxx High Yield Corporate Fund iShares Lehman Intermediate Credit Bond iShares JPMorgan Emerging Markets Bond

*Yield data as of 12/31/11

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ETFs used in the Ultimate Income Portfolio. Yield% 2.15 3.76 2.47 2.85 2.97 4.09

One of the best ways to gain exposure to high yield, intermediateterm bonds is with the iShares High Yield Corporate Bond Fund (HYG). This fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the iBoxx $ Liquid High Yield Index. Basically, this diversified fund is comprised of high yield debt of over 450 companies with credit ratings below BBB and an effective average duration of less than 5 years. It is during bullish times that we would seek to get a higher

7.18 3.32

allocation to bond funds such as HYG. In addition, as a core strategy in our Ultimate Income Portfolio, we will look to pair a high yield bond fund with a high quality bond fund to offset the

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credit risk.

One of the best ways to gain exposure to high quality, long-term government bonds is with the iShares Barclays 20+ Year Treasury Bond (TLT). This fund seeks to approximate the total rate of return of the long-term sector of the United States Treasury market as defined by the Barclays Capital U.S. 20+ Year Treasury Bond Index. That index includes all publicly issued, U.S. Treasury securities that have a remaining maturity greater than 20 years, are non-convertible, and that are rated investment grade by Moody’s Investors Service. Basically, this is the most stable of all government issued debt, virtually anywhere in the world. In 2011, Treasury bonds were one of the best performing asset classes which confirmed their reputation as perhaps the ultimate flight-to-safety play. It is during bearish times that we would seek to get a higher allocation to bond funds such as TLT.

Transitional Market Allocations In a transitional market, i.e., a market where stocks are bouncing around their trend lines trying to establish a bullish or bearish identity,

Dividend Equities 20%

Cash 25%

we would decrease our exposure to dividend equities and increase our exposure to bonds and cash. The chart here shows what our Ultimate Income Portfolio would look like in a transitional market.

Fixed Income 45%

Alt Investments 10%

The final step in building the Ultimate Income Portfolio is determining our use of what we call alternative income investments. Because of the unconventional nature of these investment vehicles, our position size would generally be limited to anywhere from 0% to 25% of our overall portfolio. When we talk about alternative income investments, we are talking about real estate investment trusts, or REITs, master limited partnerships, or MLPs, and closed-end mutual funds to name just a few. These alternative income investments are used primarily as tools to enhance our portfolio’s yield. They also can be used to diversify our income-generating assets, as many of these alternative investments have little or no correlation with either the trend in the wider stock market, and/or the trend in the bond market.

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Here it’s all about tailored exposure to market segments that are

Alternative Income Funds Ticker PFF CVY HGI AMLP ENY IYR PCEF

Name iShares S&P U.S. Preferred Stock Guggenheim Multi Asset Income Fund Guggenheim International Multi Asset Inc Alerian MLP ETF Claymore Canadian Energy Income ETF iShares Dow Jones US Real Estate PowerShares CEF Income Composite

performing well, and many times that performance is being driven Yield%

by conditions specific to a particular industry.

6.15

The Alternative Income Funds table shows some of the alternative

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income investments we use in the Ultimate Income Portfolio. One of the more intriguing funds on this list is actually a

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newcomer to the world of ETFs, and it’s the Alerian MLP Exchange-

6.20

Traded Fund (AMLP). This fund is a powerful mix of 25 energy

5.39

infrastructure master limited partnerships. The unique structure

4.13 8.36

*Yield data as of 12/31/11

of this fund allows for the elimination of any K-1 tax reporting, yet the fund still pays qualified dividends to shareholders. Think of AMLP as an energy play, because as North America’s energy transportation dynamics change, billions of investment dollars will be required for new natural gas and oil pipeline infrastructure. That puts energy MLPs at the forefront of this growth trend.

Active management is the key to a thriving income portfolio. You can no longer simply buy and hold an asset and just wait for the income to roll in. These days, you have to go out and grab it. At Fabian Wealth Strategies, we know how to grab it

Bear Market Allocations In a bear market, we would significantly

Dividend Equities 10%

Cash 25%

decrease our exposure to dividend equities and significantly increase our exposure to fixed-income assets such as bonds. The chart here shows what our Ultimate Income Portfolio would look like in a bear market.

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Fixed Income 60%

Alt Investments 5%

Now Is the Time To Take the Ultimate Step The right mix of income-generating assets, and the expertise to navigate through changing market conditions. These are the two critical components of the Ultimate Income Strategy, and it’s what we are proud to provide our Fabian Wealth Strategies’ clients. By far the biggest problem we see with new client income portfolios is they tend to be too concentrated in one asset class. Sometimes, a high concentration in one sector works well, but over time, it will doom your income holdings to a life of volatile or mediocre returns. We believe that the best way you can achieve both capital appreciation and income generation is by diversifying your income portfolio among the three asset classes outlined in this report. But we can only help you if you get in touch with us first. Success requires planning, and planning for success is what we do at Fabian Wealth Strategies. We are a fee-only wealth management firm that helps clients achieve their goals by providing a clear pathway to success. At Fabian Wealth Strategies, we help you take the steps necessary to get your income portfolio on the right track.

So, take the ultimate step, and contact us today to discuss our current allocation and strategies by calling 800-391-1118 or visit www.fabianwealth.com. Sincerely,

F W S Fa b i a n W e a l th S trat e g i e s

3070 Bristol St, Suite 610 • Costa Mesa, CA 92626 • T. 800.391.1118 • F. 714.668.9813 W W W . F A B I A N W E A L T H . C O M

Fabian Wealth Strategies, Inc. is a registered investment adviser with the U.S. Securities and Exchange Commission. Doug Fabian is a registered investment advisor representative. The information expressed by Fabian Wealth Strategies is for informational purposes only and should not be construed as a recommendation to buy, sell, or hold any specific security. Investors must meet minimum asset size of $250,000 in combined accounts. Fabian Wealth Strategies clients may own investments described in this report. Not all client accounts will replicate the exact allocations described above. All data in this report is as of 12/31/2011 unless otherwise noted. Yield data courtesy of Bloomberg Professional. Investing involves risk, including the possible loss of principal. Carefully consider the investment objectives, risks, and charges and expenses of any exchange traded fund before investing. This and other information can be found in their prospectuses.