STRATEGIES & IDEASOn FOR THE CHARLES SCHWABInvesting COMMUNITY • winter 2014

The Risks of Chasing Yield PAGE 27 A Strategy for Wise Giving PAGE 24 Demystifying ETF Trading PAGE 17

Time to Think Reasons to consider overseas Globally? real estate PAGE 20

OI-Wi14-Q4-C1 dOI_Wi14_C1_Cover_rev.indd 1 10/2/14 12:24 PM T:8”

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1Offer not available for borrowers in the State of Florida. In order to participate, the borrower must agree that the lender, Quicken Loans, may share their information with Charles Schwab Bank. This offer is a 0.250% rate discount during the initial fixed-rate period only for all 5/1 Adjustable-Rate Mortgages (ARMs) offered through Schwab Bank’s home lending program provided by Quicken Loans. Borrower must apply between October 1, 2014, and December 31, 2014, to receive this offer. Borrower’s application date is printed on the Good Faith Estimate (GFE). As part of the Schwab Bank home loan program from Quicken Loans, the borrower will also receive a closing cost discount of $200. Both offers are good only for mortgages that close. Both offers exclude Home Equity Lines of Credit. The closing cost discount will appear on the borrower’s final HUD-1 statement at closing. 5/1 ARM as of 09/24/14. 0.0% points: This Adjustable-Rate Mortgage (ARM) offers principal and interest payments based on a 30-year amortization with a fixed rate of interest for the first five years and may adjust annually thereafter for the remaining 25 years using a fully indexed rate (index plus margin) rounded to the nearest 0.125%. For example, during the first five years, the initial payment on a 30-year $650,000.00 loan is $2,784.45 at 3.125%, with 75% loan-to-value, 0% points due at closing, and 2.994% Annual Percentage Rate (APR). After the initial five years, the fully indexed rate will adjust annually, in which case your payment may increase. Based on a recently published index, the initial fully indexed rate rounded to the nearest 0.125% would be 2.875%, with principal and interest payments of $2,709.13. Disclosed payments do not include taxes and insurance premiums, so the actual payment amount may be greater. Due to market fluctuations, interest rates are subject to change at any time and without notice and are subject to credit and property approval based on underwriting guidelines. The rates and APRs shown are based on the purchase of an owner-occupied, single-family residence, for our best-qualified customers. Your individual rate may vary. This offer is subject to change or withdrawal at any time and without notice. Nothing herein is or should be interpreted as an obligation to lend. Loans are subject to credit and property approval. Other conditions and restrictions may apply. Hazard insurance may be required. Program terms and conditions are subject to change. Charles Schwab Bank and Charles Schwab & Co., Inc., are separate but affiliated companies and subsidiaries of The Charles Schwab Corporation. Investment products are offered by Charles Schwab & Co., Inc. (Member SIPC), are not insured by the FDIC, are not deposits or obligations of Charles Schwab Bank, and are subject to investment risk, including the possible loss of principal invested. Charles Schwab & Co., Inc., does not solicit, offer, endorse, negotiate, or originate any mortgage loan products and is neither a licensed mortgage broker nor a licensed mortgage lender. Home lending provided by Quicken Loans Inc., an Equal Housing Lender. Quicken Loans Inc. is not affiliated with The Charles Schwab Corporation, Charles Schwab & Co., Inc., or Charles Schwab Bank. Deposit and other non-home-lending products are offered by Charles Schwab Bank, Member FDIC and an Equal Housing Lender. Home lending is provided by Quicken Loans Inc., the home loan provider of Charles Schwab Bank. Quicken Loans Inc., Equal Housing Lender, is not affiliated with The Charles Schwab Corporation, Charles Schwab & Co., Inc., or Charles Schwab Bank, Equal Housing Lender. Lending services provided by Quicken Loans Inc., a subsidiary of Rock Holdings Inc. “Quicken Loans” is a registered service mark of Intuit Inc., used under license. Licensed in all 50 states. State-specific license information: Arizona: Quicken Loans Inc., 16425 North Pima, Suite 200, Scottsdale, AZ 85260, Mortgage Banker License #BK-0902939; Arkansas: Quicken Loans Inc., 1050 Woodward Avenue, Detroit, MI 48226-1906, 1-888-474-0404; California: Licensed by Department of Corporations, CA Residential Mortgage Lending Act; Colorado: Quicken Loans Inc., NMLS #3030, 1-888-474-0404, Regulated by the Division of Real Estate; Georgia: Residential Mortgage Licensee (#11704)—1050 Woodward Avenue, Detroit, MI 48226-1906; Illinois: Residential Mortgage Licensee #4127—Department of Financial and Professional Regulation, 1050 Woodward Avenue, Detroit, MI 48226-1906; Maine: Quicken Loans Inc., Supervised Lender License NMLS #3030; Massachusetts: Quicken Loans Inc., Mortgage Lender License #ML-3030; Minnesota: Not an offer for a rate lock agreement; Mississippi: Licensed by the Mississippi Department of Banking and Consumer Finance; Nevada: Quicken Loans Inc., 8860 S. Maryland Parkway, Las Vegas, NV 89123, License #356738; New Hampshire: Licensed by the NH Banking Department, #6743MB; New Jersey: Licensed Mortgage Banker—NJ Department of Banking, first (and/or second) mortgages only; New York: Licensed Mortgage Banker—NYS Banking Department; Oregon: Quicken Loans Inc.—License #ML-1387; Pennsylvania: Licensed as a first Mortgage Banker by the Department of Banking and licensed pursuant to the Pennsylvania Secondary Mortgage Loan Act; Rhode Island: Licensed Lender; Texas: Quicken Loans Inc., 1050 Woodward Avenue, Detroit, MI 48226-1906; Virginia: Quicken Loans Inc., NMLS ID #3030 (www.nmlsconsumeraccess.org); Washington: Consumer Loan Company License CL-3030; Quicken Loans Nationwide Mortgage Licensing System #3030. Restrictions may apply. Equal Housing Lender. ©2014 Charles Schwab Bank. All rights reserved. Member FDIC. Equal Housing Lender. CLB (1114-6223) (09/14) ADP82824-00 SCHWAB BANK ADVERTISEMENT

050899_HomeLending_OnIvesting_PrintAd_MECH.inddOI-Wi14-Q4-C2 1 9/25/14 12:03 PM dOI_Wi14_C2-C4.indd 2 10/2/14 12:22 PM CONTENTS

4 DEPARTMENTS 27 3 CEO’s Note In search of higher yields. By Walt Bettinger 4 The Bottom Line ‘Go-anywhere’ funds, year-end tax strategies and more. 14 8 Ask Carrie Set up your grad for success. By Carrie Schwab-Pomerantz 10 Perspectives Retirement How to live off your nest egg. By Rob Williams

12 Bonds 17 What this year’s price signals mean for bond investors. By Kathy Jones

14 Taxes A tax-smart approach to your cost basis. By Rande Spiegelman FEATURES 17 Trading 20 Demystifying ETF trading. 20 CAPITALIZING ON By Michael Iachini GLOBAL REAL ESTATE Consider overseas property 30 Spotlight investments to balance The latest products and your portfolio. services from Schwab. 34 Research 24 GIVING WISELY Schwab Mutual Fund Make the most of your charitable OneSource Select List® giving by thinking strategically.

43 Schwab ETF Select List® 27 WORTH THE RISK? Why preferreds, REITs and MLPs 47 Argus Research aren’t substitutes for bonds. 48 On Your Side GO PAPERLESS Ready to engage. Log in to schwab.com/OIpaperless to receive email alerts By Charles R. Schwab when new issues of On Investing are available online. You can also scan here to download the On Investing app for iPad®.

CONNECT 888-484-5340 @charlesschwab schwab.com/emailus WITH US schwab.com facebook.com/charlesschwab

On Investing (ISSN 1523-5327) is published quarterly. This publication is mailed at Standard A postal rates. If you prefer not to receive On Investing, please call 888-484-5340. Apple, the Apple logo, iPad and iPhone are trademarks of Apple, Inc., registered in the United States and other countries. POSTMASTER: Send address changes to On Investing, Charles Schwab & Co., Inc., P.O. Box 52114, Phoenix, AZ 85072–2114. On Investing does not assume any liability resulting from actions taken based on the information included in this magazine. Mention of a company or security does not constitute endorsement. Some contributors to

Cover Illustration: Greg Mably On Investing may have active positions in securities or companies discussed in this issue. NWS73442Q414

WINTER 2014 • ON INVESTING 1

OI-Wi14-Q4-1 dOI_Wi14_1_TOC.indd 1 10/2/14 1:14 PM dOI_Wi14_2-3_Disc_CEO.indd 2 S 2 O chwab Centerfor In “InvestingforIncomeandGrowth WithDividend-Paying Stocks”onpage 33,weincorrectly identified Procter &Gambleas Proctor &Gamble. after youretire. Thisisonlytrueforyourcurrent employer-sponsored Standard RMDrulesstillapply forallotherretirement accounts youhold. account. We alsostatedthatifyouare 70½orolderandstill workingandcontributingtoanemployer-sponsored retirement plan,youcandelayyourfirstRMD until While thatistrueforIRAs,RMDsqualifiedemployer-sponsored mustbewithdrawnfrom eachaccountseparately. retirement plans,suchas401(k)s, In “DemystifyingRMDs”onpag Thank youtoreaders whopointedoutincompleteanderroneous informationinourFall 2014edition. C Carrie Schwab-Pomerantz A Marketing LARIFI n sso Charl I Content &ClientMarketing c nvesting iat Mark W. Riepe,CFA Executive C Charles R. Schwab Charles R. Rande Spiegelman Chief Marketing Officer Board of ATION S e S S

trategy & trategy Jennifer Newton m m enior enior e Jonathan Craig Jeremy Hartley F Michael Iachini Stephanie May anagi anaging anaging Larry Hanback Walt Bettinger T inancial s s e Tamar Dorsey c rading rading Rob Williams ditor ontri Kathy Jones V V V V

AND ice President ice President ice President ice President c Helen Loh ng A O hwa dvisors in perations R b C esearch e e e utors ditor ditor ditor c ORR hi b retirement account but can be taken from any account. e 5,westatedthatRMDsmustbecalculatedseparatelyforeachretirement accountbutcanbetakenfrom anyaccount. e •Wint n i W • OI-Wi14-Q4-2 f EC TION e r 2 014 014 2 r e

Fundamental Index Corporation. (p. 31) & Co., Inc., thedistributorforSchwabFunds, are separatebutaffiliatedcompaniesandsubsidiaries ofTheCharlesSchwab Inc.,theinvestmentadvisor for Schwab’sCharles SchwabInvestmentManagement, proprietary funds,andCharlesSchwab All expressions ofopinionare subjecttochange withoutnoticeinreaction toshiftingmarketconditions.(p. 5) Diversification strategiesdonotensure aprofit anddonot protect againstlossesindecliningmarkets. (p. 20–23,27–29,31) 20–23, 27–29) Indexes are unmanaged, donotincurmanagement fees,costsorexpenses,andcannotbeinvestedindirectly. (p. 6–7,17–19, basket ofconsumergoods andservices.(p. 12–13) The ConsumerPrice Indexisameasure takenbytheU.S. government thatcalculatestheweightedaverage of pricesofa liquidity andindustrygroup representation. (p. 5,6–7,17–19) The S&P500 (p. 5) GlobalMarketandCapitalMarket. Select, The NASDAQ CompositeIndexisabroad-based capitalization-weightedindexofstocksinallthree NASDAQ tiers:Global markets mayaccentuatetheserisks.(p. 20–23,31) foreignfluctuations, taxesand geopolitical risk, regulations,andthepotentialforilliquidmarkets.Investinginemerging International investmentsinvolveadditionalrisks,includingdifferences infinancialaccountingstandards, currency callable. (p. 27–29) Preferred stocksgenerally havelowercredit ratingsandlowerclaimtoassetsthanafirm’s individualbonds,andare often (p. 27–29) buying andselling,regulatory oversight. includingrisksrelated totaxtreatmentstock, cashflow,Additional risksincludevolatility, dilutionandvotingrights. difficulty Investing inmaster-limited partnerships(MLPs) involvesadditionalrisksascompared totherisksofinvestingincommon demand, andthemanagement skillandcreditworthiness oftheissuer. (p. 3,20–23,27–29,31) such aschanges inreal estatevaluesandproperty taxes,interest rates,cashflowofunderlying real estateassets,supplyand Risks ofinvestinginreal estateinvestmenttrusts(REITs) are similartothoseassociatedwithdirect ownershipofreal estate, considered. Pleasecontactataxadvisorfortheimplicationsinvolvedinthesestrategies.(p. 17–19) Commissions, taxesandtransactioncostsare notincludedinthisdiscussion,butcanaffectfinaloutcomeandshouldbe Shares are boughtandsoldatmarketprice,whichmaybehigherorlowerthanthenetassetvalue.(p.cost. 17–19) subject tomarketvolatility, sothataninvestor’s shares, whenredeemed orsold,maybeworthmore orlessthantheiroriginal Some specializedexchange-traded fundscanbesubjecttoadditionalmarketrisks.Investmentreturns willfluctuateandare Lower-rated (p. securitiesare subjecttogreaterdefaultriskandliquidityrisk. 4,12–13,27–29) credit risk, early redemption, corporateevents,taxramificationsandotherfactors.(p. 3,4,12–13,27–29) investments are subjecttovariousotherrisks,includingchanges incredit quality, marketvaluations,liquidity, prepayments, Fixed incomesecuritiesare subjecttoincreased lossofprincipalduringperiodsrisinginterest rates.Fixedincome (p.Investing involvesrisks,includinglossofprincipal. 3,5,6–7,10–11,48) Imp ©2014 CharlesSchwab&Co., Inc.Allrightsreserved. MemberSIPC. (1114-5917) situation. Consultyourtaxadvisorformore information.(p. 5) A donor’s ability to claimitemizeddeductionsissubjectavarietyoflimitationsdependingonthedonor’s specific tax planner orinvestmentmanager. (p. 5,10–11,14–16,30) specific adviceisnecessaryorappropriate, Schwab recommends consultationwithaqualified taxadvisor, financial CPA, This informationisnotintendedtobeasubstituteforspecificindividualizedtax,legalorinvestmentplanningadvice.Where investment decision.(p. 3,4,5,8–9,10–11,12–13,14–16,17–19) everyone. Eachinvestorneedstoreview aninvestmentstrategyforhisorherownparticular situationbefore makingany recommendation orpersonalizedinvestmentadvice.Thestrategiesmentioned here maynotbesuitablefor The informationprovided here isforgeneral informationalpurposesonlyandshouldnotbeconsidered anindividualized Housing Lender), provides depositandlendingservicesproducts. (p. 48) products, includingSchwabbrokerage accounts.Itsbankingsubsidiary, CharlesSchwabBank(memberFDICandanEqual operating subsidiaries.Itsbroker-dealer subsidiary, CharlesSchwab&Co., Inc.(memberSIPC), offersinvestmentservicesand The CharlesSchwabCorporationprovides afullrange ofbrokerage, bankingandfinancialadvisoryservicesthrough its The SchwabCenterforFinancialResearch isadivisionofCharlesSchwab&Co., Inc.(p. 5, 10–11, 12–13, 14–16, 20–23, 27–29) Charles SchwabInvestmentAdvisory, Inc.,isanaffiliateofCharlesSchwab&Co., Inc.(p. 17–19) ortant ® Indexisamarket-capitalization-weighted indexcomprising500widelytradedstockschosenformarketsize, ® D isaregistered trademarkofResearch Affiliates,LLC. (p. 31) is c losur e s 10/9/14 1:22PM

©Schwab Photo Library

I (1114-4702) information. See page2forimportant fixed income alternatives on yourportfolio. We impact helpthe can you understand of H I better or worse. returnsto seek elsewhere—for rates might eventempt investors unwelcome. In somelow cases, of income, low rates are most bonds to generate asteady stream not alone. For rely who those on approach isn’t for everyone. associated with equities, but that can tolerate increased risk the might work for investors who for equity-income investments swapping out bond investments solutions.size-fits-all For example, due diligence—there are no one- conductedbe with great care and huntthe for yield should higher larger risks involved. that are to the justify small too mutual funds, may deliver returns as nontraditional fixed income diversifiedportfolio. Others, such generating income of as part a shoulder some of burden the of bonds, could potentially help still (REITs), more while risky than as real estate investment trusts have turned. Some of such them, to investors yield-seeking which intolook afew of alternatives the As with any investing strategy, ,we In issue this of income investments, you’re low yields from your fixed f you’ve frustrated by been ceo’s note

In Search of changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, Higher Yields and the management skill and creditworthiness of the issuer. (p. 3, 20–23, 27–29, 31) We can help you understand the impact of stock, including risks related to tax treatment cash flow, dilution and voting rights. Additional risks include volatility, difficulty fixed income alternatives on your portfolio. buying and selling, and regulatory oversight. (p. 27–29) Preferred stocks generally have lower credit ratings and lower claim to assets than a firm’s individual bonds, and are often callable. (p. 27–29) f you’ve been frustrated by Bondholders should also be International investments involve additional risks, including differences in financial accounting standards, currency low yields from your fixed aware that, as rates begin to fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging income investments, you’re rise and prices correspondingly markets may accentuate these risks. (p. 20–23, 31) I not alone. For those who rely on begin to decline, it may become The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. (p. 5) bonds to generate a steady stream more challenging to sell the fixed of income, low rates are most income investments they already unwelcome. In some cases, low hold in their portfolios without rates might even tempt investors incurring significant losses. basket of consumer goods and services. (p. 12–13) to seek returns elsewhere—for However you address your Indexes are unmanaged, do not incur management fees, costs or expenses, and cannot be invested in directly. (p. 6–7, 17–19, better or worse. situation, a low-yield environment 20–23, 27–29) In this issue of On Investing, we doesn’t mean you should lower Diversification strategies do not ensure a profit and do not protect against losses in declining markets. (p. 20–23, 27–29, 31) All expressions of opinion are subject to change without notice in reaction to shifting market conditions. (p. 5) look into a few of the alternatives your standards when it comes to which yield-seeking investors to making investment decisions. have turned. Some of them, such Our experienced fixed income as real estate investment trusts professionals can help guide you is a registered trademark of Research Affiliates, LLC. (p. 31) (REITs), while more risky than through the bond market as you Charles Schwab Investment Advisory, Inc., is an affiliate of Charles Schwab & Co., Inc. (p. 17–19) bonds, could potentially still help consider yield-generating ideas. The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc. (p. 5, 10–11, 12–13, 14–16, 20–23, 27–29) shoulder some of the burden of With bond yields likely to The Charles Schwab Corporation provides a full range of brokerage, banking and financial advisory services through its generating income as part of a rise in the coming years, we will operating subsidiaries. Its broker-dealer subsidiary, Charles Schwab & Co., Inc. (member SIPC), offers investment services and diversified portfolio. Others, such make sure you have all of the “The hunt for as nontraditional fixed income information necessary—in the mutual funds, may deliver returns transparent Schwab way—to help higher yield that are too small to justify the you achieve your financial goals. should be larger risks involved. As with any investing strategy, Sincerely, conducted the hunt for higher yield should be conducted with great care and with great care due diligence—there are no one- and due diligence.” size-fits-all solutions. For example, swapping out bond investments for equity-income investments might work for investors who can tolerate the increased risk associated with equities, but that Walt Bettinger approach isn’t for everyone. President & CEO

See page 2 for important information.

©Schwab Photo Library (1114-4702)

Winter 2014 • on investing 3

OI-Wi14-Q4-3 dOI_Wi14_2-3_Disc_CEO.indd 3 10/2/14 11:54 AM The bottom line

the 5.7% return on corporate bond funds Morningstar ‘Go-Anywhere’ Funds tracked during the period. Although nontraditional funds haven’t been Does the potential for higher yields performing particularly well as a group, it’s important outweigh the risks? to understand that management styles vary widely between funds. Some managers may adopt risky ith interest rates hovering near historic strategies or invest heavily in high-yield bonds, while lows, some yield-hungry fixed income others may be fairly conservative. W investors have poured money into a variety Investors interested in nontraditional bond funds of nontraditional fixed income funds. should pay attention to a fund’s investment strategy and Unlike traditional fixed income funds, which tend other information available to shareholders. They should to target specific parts of the bond market, such as also consider these funds a complement to, rather than a municipal or corporate bonds, nontraditional funds can replacement for, traditional core bond funds. - hold debt from any type of issuer, with any type of credit Next Steps rating and in any maturity. 1Conrad De Aenlle, “When Bond Funds Think Outside the Box,” Call a Fixed In theory, such flexibility enables nontraditional bond The New York Times, 4/4/2014. Income funds to focus on higher-yielding investments, which is See page 2 for important information. Specialist at likely contributing to their appeal. Assets in such funds 866-893-6699 Investors should carefully consider information contained for help rose about 80% to $123 billion in 2013, and grew another in the prospectus, including investment objectives, risks, 1 determining 7% to $132 billion in the first two months of 2014. charges and expenses. You can request a prospectus by which bond However, the freedom to look for yield doesn’t visiting schwab.com or calling Schwab at 800-435-4000. investments are always pay off. According to fund-research company Please read the prospectus carefully before investing. appropriate for Morningstar, nontraditional bond funds had a 2.5% year- Past performance is no guarantee of future results.

your portfolio. to-date return through June 23, 2014. That’s less than half (1114-4542) ©James Steinberg

4 Charles schwab • W i n t e r 2 014

OI-Wi14-Q4-4 dOI_Wi14_4-5_BottomLine.indd 4 10/2/14 1:19 PM Are Technology Stocks Getting Taxes: 4 Things to a Reboot? Check This Year Several factors suggest the Optimize your tax situation before 2015. potential for outperformance in the IT sector. ith the end of the year approaching, now is a great time to give your finances an annual tax checkup. Here are four arlier this year, the tech-heavy NASDAQ W items to consider. Composite Index® shed roughly 8% over E a few weeks as investors suddenly cashed Check your withholding. If you’ve had any changes to your out of fast-growing technology and social media finances that could affect your tax situation—such as a new job, stocks. The ensuing talk of a slump in tech extra income from a side business, or a new or refinanced mortgage— stocks may have overshadowed some attractive it’s a good idea to review and, if necessary, adjust your tax withholding possibilities in the sector. before the end of the year. Doing so helps position you for a more tax- For one thing, we may be at the beginning efficient 2015. of an information technology (IT) investment cycle that could boost sales for tech companies, Reduce your capital gains. If you have losing investments, says Brad Sorensen, Director of Market and you may want to sell them before the end of the year and write Sector Analysis at the Schwab Center for off the losses. Selling now allows you to reposition your portfolio Financial Research. “Businesses that delayed allocations and helps offset any realized capital gains. And if your IT investments in the wake of the 2008–2009 capital losses exceed your capital gains by more than $3,000, you can financial crisis are long overdue for upgrades,” he carry forward those losses to future tax years. says. IT research firm Gartner expects businesses NOTE: If you plan to reinvest in a losing position, watch out for in mature markets to replace roughly 60 million the “wash sale” rule, which prohibits you from claiming a loss if personal computers by the end of 2014.1 you replace the losing security with the same or a “substantially Brad also says some established tech identical” investment within 30 days before or after the sale. companies have been introducing or boosting dividends in recent years, potentially making the 5.7% return on corporate bond funds Morningstar Take required minimum distributions (RMDs) on time—or face IT stocks appropriate for investors focused tracked during the period. a steep penalty. The IRS requires investors who are age 70½ or on equity income. According to S&P Capital Although nontraditional funds haven’t been older to take annual distributions from most retirement accounts by the IQ data, 44 stocks in the S&P 500® Index’s performing particularly well as a group, it’s important end of the year. If you don’t withdraw the required sum on time, you may IT sector paid dividends in 2013, yielding an to understand that management styles vary widely face a penalty amounting to 50% of any funds you should have withdrawn. average 1.63%. This is a significant change from between funds. Some managers may adopt risky NOTE: If you turned 70½ in 2014, you have until April 1, 2015, to 2010, when the 32 dividend-paying stocks in strategies or invest heavily in high-yield bonds, while take your first RMD. However, if you delay until then, you will still the sector had an average yield of 0.94%.2 others may be fairly conservative. have to take your next withdrawal by December 31, 2015, meaning “A few of the high-flying technology Investors interested in nontraditional bond funds you would be taking two RMDs in 2015, potentially increasing your companies from the late 1990s are now some should pay attention to a fund’s investment strategy and income and tax burden for the year. of the most stable, income-generating stocks in other information available to shareholders. They should the market,” Brad says. - also consider these funds a complement to, rather than a Make your giving tax efficient. Gifts to qualified charities must be replacement for, traditional core bond funds. made before the end of the year to qualify for a tax deduction. Save Do t h e R e s e a rc h receipts for donations of $250 or more. You may also want to consider Review Schwab’s top-rated technology stocks by logging in to donating appreciated securities. Doing so allows you to claim the full schwab.com/OIstocks and clicking market value of the donated securities as a the Schwab Stock Lists™ tab. deduction while avoiding capital gains taxes. But don’t donate depreciated securities— you’re better off selling those, taking the tax 1Michael McEnaney, “Signs of Life in PC Market? Consumers/ Next Steps Business Looking for More Muscle Than Tablets Offer,” benefit and then donating the cash. - For more tax help and TechTimes.com, 7/8/2014. to access year-end 2Constance Gustke, “High Dividend-Paying Tech Stocks Still See page 2 for important information. tax documents, visit Undervalued,” CNBC.com, 3/12/2014. (1114-4541) schwab.com/OItax. See page 2 for important information.

©James Steinberg (1114-4543)

Winter 2014 • on investing 5

OI-Wi14-Q4-5 dOI_Wi14_4-5_BottomLine.indd 5 10/2/14 11:59 AM As January Goes, Should So Goes the Year This refers to the idea that if the market rises in January, it will go 90% Market on to post gains for the full year. In True the 64 years covered by our data, That when January posted gains in 40 of them. January And in 36 of those 40 years, the posted gains, Adages the market market went on to record gains for ended the Guide Your the full year. year higher Investing?

ver the years, several adages based on supposed seasonal Opatterns in stock market returns have taken So should you try to hold. Some investors treat time the market? these sayings as established No. wisdom and use them to 7% make important decisions 6% s n about when to get in or out i

ga 5% of the market. But should a e 4% saying take the place of ntag

erce 3% ly P ly

a strategy? i 2% Here we take a closer look da 1% at a few of these adages,

examining their accuracy over Jan FEB MAR APR a 64-year period.

Source: Schwab Center for Financial Research. Market returns based on Staying in the market over the long term can help S&P 500® Index from 1950–2013. Conclusion: big trading days come along. Some adages might seem like conventional See page 2 for important information. wisdom, but they shouldn’t guide your investing decisions or distract you Past performance is no guarantee of future results. Stay Invested from your long-term investing strategy. (1114-6019)

6 Charles schwab • W i n t e r 2 014

OI-Wi14-Q4-6 dOI_Wi14_6-7_Infographic_082814.indd 6 10/2/14 12:00 PM Sell in May and Go Away Santa Claus Rally This adage suggests that the stock This refers to the idea that market will see losses for the period 34% stocks tend to surge at the end 77% between Memorial Day and Labor True of the year, partly as a result of True Day, so it’s better to pull out of the That the tax considerations. In fact, the That the market altogether during the summer market market rallied in 49 of the 64 market months. However, our research fell in the years studied, and a positive rallied in summer December shows that this was only true in 22 months December preceded a positive of the 64 years studied. January two-thirds of the time.

Although some adages have proved more reliable than others over the years, the market 2009 can surge at any time. The chart below shows the 10 biggest single-day stock market 2010 2011 gains in each of the past five years. As you can see, trying to time the market would have 2012 No. meant missing out on major single-day gains in some years. 2013

MAY JUN JUL AUG SEP OCT NOV DEC

Next Steps Staying in the market over the long term can help ensure you benefit when Find more of Schwab’s big trading days come along. Some adages might seem like conventional market research wisdom, but they shouldn’t guide your investing decisions or distract you and commentary at schwab.com/ from your long-term investing strategy. OImarketinsight.

Winter 2014 • on investing 7

OI-Wi14-Q4-7 dOI_Wi14_6-7_Infographic_082814.indd 7 10/2/14 12:00 PM Ask Carrie

Provide a savings incentive Saving is one of the hardest things to do on a small salary, but still one of the most important. Encourage your son to open a savings account where he can sock Set Up Your away money for an apartment, a car or other goals. Also talk to him about the importance of having an Grad for Success emergency fund. As an incentive, How financial support and independence you could offer to match a portion of his savings. can go hand in hand. Once he’s earning some money, By Carrie Schwab-Pomerantz encourage him to take advantage of his 401(k) if his company offers one. If not, have him open an IRA. (Roth IRAs, which are funded Dear Carrie, of New York estimates that up to Make your with after-tax dollars and offer 44% of recent college graduates support specific tax-free growth and earnings, My 22-year-old son graduated hold jobs that don’t require a There are a couple of ways to as well as tax- and penalty-free from college last spring. Now bachelor’s degree.2 Before we jump do this, and they should apply withdrawals in retirement, are he’s struggling to find a job— to conclusions, we should realize that whether your son has a place of particularly practical for younger even though these unemployment his own or is still living at home. investors, who are likely to be in a and I’m tr ying to figure out my and underemployment rates are (Having a young adult at home lower tax bracket today than they role as he transitions to life in higher than in the recent past, they’re wouldn’t be surprising. According will be in retirement.) Again, you not far off historical norms. As the to Pew Research Center, 56% of might offer to match his savings, the real world. How can I help Federal Reserve study also points adult children ages 18–24 live with or contribute a certain amount him find his footing ? out, it is actually quite common their parents.4) with the proviso that he has to add —A Reader for young graduates to take several Let’s say he finds a part-time a percentage of his own income years to successfully transition into a job. First, discuss his expenses every month. meaningful career path. with him: transportation, food, A colleague of mine did this Dear Reader, The one thing that has changed clothes, entertainment, credit with her daughter several years ago significantly over time is how card balances, student loan and now has the pleasure of seeing ou’re certainly not alone much an education costs. With the payments, possibly even rent her not only saving regularly, but in facing this quandary. combined cost of tuition, room paid to you to cover his share of managing a growing retirement Y Whether you’re talking to and board at some colleges topping household expenses. Help him account and handling her own other parents or reading the news, $200,000 for a four-year degree,3 draw up a monthly budget and investing. That brings me to the the consensus is that it’s difficult for the sting of unemployment or talk about what his salary will next point. today’s college graduates to find a underemployment is that much cover. Then you can consider job. That’s corroborated by the U.S. more acute. Even so, a degree is supplementing his paycheck Bureau of Labor Statistics, which put likely worth the investment— to help cover his essentials, the unemployment rate for recent unemployment rates are about provided you can afford to do so. 1Thomas Luke Spreen, “Recent College Graduates in the U.S. Labor Force: Data from the Current Population Survey,” graduates with a bachelor’s degree at 50% higher for those without a If your son is living on his 2Jaison R. Abel, Richard Deitz and Yaqin Su, “Are Recent College Graduates Finding Good Jobs?” Federal Reserve Bank of New York, , 13.5% in 2011 (the most recent year college degree. own, be clear about how you Vol. 20, No. 1 (2014). 3“A New Era: $60K Per Year Colleges,” CampusGrotto.com, 10/4/2012. for which statistics on this subset of The lesson is that the “real world” will help support him. Ask to 4Richard Fry, “A Rising Share of Young Adults Live in Their Parents’ Home,” Pew Research Center’s Social & Demographic Trends, 8/1/2013. graduates are available).1 may look a little different than we— see his budget so that you know 5Withdrawals from a Roth IRA are generally tax- and penalty-free if the account has been open for at least five years and the withdrawals are taken after age 59½. But it’s not just a matter of and our recent graduates—anticipated. exactly where your money is See page 2 for important information. unemployment; it’s also a matter Nonetheless, there are still some going. You won’t be helping him To receive a complimentary copy of , attend a branch workshop and request one. Workshops require registration, and of underemployment. A 2014 positive steps we can take to help them achieve independence if you space is limited. Book available while supplies last; one per person; only U.S. residents over 18 are eligible. Other restrictions may apply.

study by the Federal Reserve Bank get a handle on their finances. pay for everything. ©Schwab Photo Library (1114-5210)

8 Charles schwab • W i n t e r 2 014

OI-Wi14-Q4-8 dOI_Wi14_8-9_Carrie.indd 8 10/2/14 12:01 PM Provide a Lead by example in the thousands for even the savings incentive Share your experiences with most entry-level jobs, a personal Saving is one of the hardest money management and investing. connection is invaluable. Even an things to do on a small salary, but The colleague I mentioned earlier informational interview can be still one of the most important. helped her daughter get into an important learning experience Encourage your son to open a investing by going over her own and could open the door to future savings account where he can sock portfolio with her daughter and opportunities. away money for an apartment, a introducing her to some of the car or other goals. Also talk to him investing tools on schwab.com. Provide advice—up about the importance of having an Schwab.com/OImoneywise is to a point emergency fund. As an incentive, a great place to begin your son’s Graduates should understand that you could offer to match a portion investing education. There you’ll they most likely won’t end up in of his savings. find not only information and tools their dream jobs immediately after Once he’s earning some money, to help with budgeting and saving, collecting their diplomas. And we Next Steps Attend a branch encourage him to take advantage but also a good introduction parents need to understand our workshop near of his 401(k) if his company offers to investing concepts and basic kids’ employment challenges and you and receive one. If not, have him open an IRA. portfolio construction. be realistic about the difficulties a complimentary (Roth IRAs, which are funded Once your son has this and time involved in landing a copy of Carrie’s with after-tax dollars and offer information under his belt, you job today. latest book, The tax-free growth and earnings, can help him get started with a I encourage you to talk openly Charles Schwab There are a couple of ways to as well as tax- and penalty-free broadly diversified investment like with your son about his goals and Guide to Finances do this, and they should apply withdrawals in retirement,5 are an index mutual fund or exchange- your expectations. But ultimately, After Fifty (Crown whether your son has a place of particularly practical for younger traded fund (ETF). With some your son’s life is his own, and it’s Business, 2014). his own or is still living at home. investors, who are likely to be in a seed money in his IRA, investing appropriate for him as a young Reserve your seats (Having a young adult at home lower tax bracket today than they can come alive—and hopefully adult to make his own decisions. As at schwab.com/ OIworkshops. wouldn’t be surprising. According will be in retirement.) Again, you inspire a lifelong interest. a supportive parent, you just have to Pew Research Center, 56% of might offer to match his savings, to be clear about the limits of your adult children ages 18–24 live with or contribute a certain amount Use your connections financial support. That will help ) with the proviso that he has to add Ultimately, you have to have each of you transition into this new Let’s say he finds a part-time a percentage of his own income money to learn to manage it life stage—and may help each of job. First, discuss his expenses every month. wisely. So if you have professional you accept the ups and downs that with him: transportation, food, A colleague of mine did this associations or friends in a field are part of your child’s personal and clothes, entertainment, credit with her daughter several years ago related to your son’s area of financial success.- card balances, student loan and now has the pleasure of seeing education and interest, don’t be payments, possibly even rent her not only saving regularly, but shy about approaching them for Carrie Schwab-Pomerantz, CFP ®, paid to you to cover his share of managing a growing retirement help with your son’s job search. is President of Charles Schwab household expenses. Help him account and handling her own Today, with the majority of Foundation and Senior Vice President draw up a monthly budget and investing. That brings me to the resumes submitted online and of Schwab Community Services at talk about what his salary will next point. the competition numbering Charles Schwab & Co., Inc. cover. Then you can consider supplementing his paycheck to help cover his essentials, provided you can afford to do so. 1Thomas Luke Spreen, “Recent College Graduates in the U.S. Labor Force: Data from the Current Population Survey,” Monthly Labor Review, February 2013. If your son is living on his 2Jaison R. Abel, Richard Deitz and Yaqin Su, “Are Recent College Graduates Finding Good Jobs?” Federal Reserve Bank of New York, Current Issues in Economics and Finance, own, be clear about how you Vol. 20, No. 1 (2014). 3“A New Era: $60K Per Year Colleges,” CampusGrotto.com, 10/4/2012. will help support him. Ask to 4Richard Fry, “A Rising Share of Young Adults Live in Their Parents’ Home,” Pew Research Center’s Social & Demographic Trends, 8/1/2013. see his budget so that you know 5Withdrawals from a Roth IRA are generally tax- and penalty-free if the account has been open for at least five years and the withdrawals are taken after age 59½. exactly where your money is See page 2 for important information. going. You won’t be helping him To receive a complimentary copy of The Charles Schwab Guide to Finances After Fifty, attend a branch workshop and request one. Workshops require registration, and achieve independence if you space is limited. Book available while supplies last; one per person; only U.S. residents over 18 are eligible. Other restrictions may apply. pay for everything. ©Schwab Photo Library (1114-5210)

Winter 2014 • on investing 9

OI-Wi14-Q4-9 dOI_Wi14_8-9_Carrie.indd 9 10/9/14 1:22 PM Perspectives: Retirement

predictable sources of income you can use to cover essential expenses. Many retirees fall into the trap of tapping their more Funding Your volatile investment assets to cover regular costs—such as housing, car loans, food and Retirement utilities—when they could be using income from more predictable sources. Paying for How to live off your nest egg. essentials with predictable income may help By Rob Williams you avoid selling investment assets to cover your bills, which can be particularly costly when the market is down. Fund discretionary expenses with fluctuating income Stock dividends, distributions from hen many investors think about mutual funds or exchange-traded funds, retirement, they focus on socking required minimum distributions from W away cash and then investing your retirement accounts, and proceeds it wisely to grow their nest egg. But there’s from selling investments are less reliable another critical—and often overlooked—piece than the predictable income sources cited of retirement planning: devising a strategy for above. Then again, they also have more withdrawing those carefully tended savings. growth potential and tend to keep pace with When it’s time to tap their savings, many inflation. This makes such income a good fit “Paying for retirees either spend too much and risk not when paying for nonessential items, such as essentials with having enough money to fund their entire vacations or gifts to a charity or grandchild. predictable retirement, or they spend too little and leave Fluctuating income from dividends and other more behind than desired. distributions also can help supplement Social income may In previous issues of On Investing, we Security payments and other sources of help you discussed the first two steps in our three-step income outside your portfolio. To help remedy an imbalance like this one, avoid selling approach to retirement income. The first article you could sell from the stock portion of your investment in the series covered planning your retirement. Generate cash flow when portfolio to generate needed cash and get assets to cover The second article discussed your portfolio’s you rebalance your portfolio your portfolio back on target. (See “Selling your bills.” allocation, or choosing the right mix of Selling investments as part of the annual investments” at right for more information.) investments to help you reach your goals rebalancing of your portfolio could provide Remember that rebalancing does not protect once your plan is in place. another opportunity to generate cash flow. you against losses or guarantee that you’ll That brings us to the final step of retirement Annual portfolio rebalancing is especially meet your goals. planning—distribution. As with the planning important when you’re retired, as your With these points in mind as you create and allocation steps, each person’s circumstances allocation should grow more conservative as your own distribution plan, watch for are unique. We all have different portfolios, and you age to help preserve your assets. A portfolio changes in your spending or income to our needs and goals are our own. That said, that’s out of balance can leave you with more ensure that your expectations are on track. some general principles apply to any retirement risk or less growth potential than you want. In a prolonged down market, for example, withdrawal strategy. It’s just a matter of drawing These risks can be magnified in volatile markets you may need to curb or postpone up a budget reflecting all of your income and because retirees have less time than younger discretionary spending to avoid drawing spending expectations, and then devising a investors to recover from the potential losses or down your portfolio too quickly. suitable distribution strategy. lackluster returns caused by a portfolio that has strayed from a chosen asset allocation. See page 2 for important information. Cover essentials with How do portfolios drift away from target The Personal Portfolio Review is complimentary, although the implementation of any recommendations made during the consultation may result in trade commissions or predictable income sources allocations? Many investors got a first-hand other fees, charges or expenses. The Personal Portfolio Review is available only to clients with at least $25,000 in assets at Schwab or prospects with at least $25,000 in assets available to bring to Schwab. Individualized recommendations are available only to Schwab clients and are limited to assets held in a Schwab retail brokerage account. Social Security, pension payments, annuities, look in 2013, when major U.S. stock indexes Information provided to prospects, or pertaining to assets held outside of Schwab, as part of a Personal Portfolio Review are examples of the kinds of recommendations interest income, or even cash or short- rose more than 25% and left many portfolios available on assets held at Schwab; these examples do not constitute recommendations, solicitations or investment advice.

term bonds kept in reserve are among the overweighted in equities. ©John Kuczala (1114-4679)

10 Charles schwab • W i n t e r 2 014

OI-Wi14-Q4-10 dOI_Wi14_10-11_PER_Williams_c.indd 10 10/2/14 12:02 PM predictable sources of income you can use to cover essential expenses. Many retirees fall into the trap of tapping their more Selling volatile investment assets to cover regular investments costs—such as housing, car loans, food and utilities—when they could be using income When it comes to selling from more predictable sources. Paying for assets, it’s usually better to part with investments essentials with predictable income may help held in taxable accounts you avoid selling investment assets to cover before taking money from your bills, which can be particularly costly tax-deferred accounts. when the market is down. Withdrawals from traditional IRAs and 401(k)s are treated as ordinary income—which is Stock dividends, distributions from typically taxed at a higher mutual funds or exchange-traded funds, rate than long-term capital required minimum distributions from gains. What’s more, tapping your retirement accounts, and proceeds your IRA means losing opportunities for tax- from selling investments are less reliable deferred compound growth. than the predictable income sources cited A possible exception is above. Then again, they also have more if your IRA balance is very growth potential and tend to keep pace with large. If that is the case, inflation. This makes such income a good fit you might want to start when paying for nonessential items, such as taking distributions before vacations or gifts to a charity or grandchild. you reach age 70½, which Fluctuating income from dividends and other is when most retirees distributions also can help supplement Social must start withdrawing Security payments and other sources of a minimum amount from income outside your portfolio. To help remedy an imbalance like this one, Creating income during retirement might their retirement savings. Otherwise, your mandatory you could sell from the stock portion of your sound daunting, but it doesn’t have to be. Three withdrawal amount might portfolio to generate needed cash and get steps—planning, allocating and distributing— bump you up to a higher your portfolio back on target. (See “Selling can help you simplify the process and lay the tax bracket. Selling investments as part of the annual investments” at right for more information.) groundwork for the kind of retirement you’ve One other thing to rebalancing of your portfolio could provide Remember that rebalancing does not protect always wanted. - consider when selling is another opportunity to generate cash flow. you against losses or guarantee that you’ll the need to weed out Annual portfolio rebalancing is especially meet your goals. Rob Williams, CFP ®, is Managing Director nonperformers. When you’re important when you’re retired, as your With these points in mind as you create of Income Planning at the Schwab Center for rebalancing your portfolio allocation should grow more conservative as your own distribution plan, watch for Financial Research. and selling assets from you age to help preserve your assets. A portfolio changes in your spending or income to taxable and tax-preferred that’s out of balance can leave you with more ensure that your expectations are on track. accounts, sell holdings with Call Us the lowest performance or risk or less growth potential than you want. In a prolonged down market, for example, Talk to us about your retirement. credit ratings to improve the These risks can be magnified in volatile markets you may need to curb or postpone Call 888-484-5340 or visit a branch quality of your portfolio. because retirees have less time than younger discretionary spending to avoid drawing near you to schedule your Personal investors to recover from the potential losses or down your portfolio too quickly. Portfolio Review. lackluster returns caused by a portfolio that has strayed from a chosen asset allocation. See page 2 for important information. How do portfolios drift away from target The Personal Portfolio Review is complimentary, although the implementation of any recommendations made during the consultation may result in trade commissions or allocations? Many investors got a first-hand other fees, charges or expenses. The Personal Portfolio Review is available only to clients with at least $25,000 in assets at Schwab or prospects with at least $25,000 in assets available to bring to Schwab. Individualized recommendations are available only to Schwab clients and are limited to assets held in a Schwab retail brokerage account. look in 2013, when major U.S. stock indexes Information provided to prospects, or pertaining to assets held outside of Schwab, as part of a Personal Portfolio Review are examples of the kinds of recommendations rose more than 25% and left many portfolios available on assets held at Schwab; these examples do not constitute recommendations, solicitations or investment advice. overweighted in equities. ©John Kuczala (1114-4679)

Winter 2014 • on investing 11

OI-Wi14-Q4-11 dOI_Wi14_10-11_PER_Williams_c.indd 11 10/2/14 12:02 PM Perspectives: bonds

And in Europe and other parts of the world, Inflation disinflation is still a real concern, even if inflation has reached a turning point here at home. All things considered, it’s probably safe for Pressure? fixed income investors to assume that, unless growth falters, short-term rates will move What this year’s price signals higher eventually. (It’s worth noting that Fed mean for bond investors. Chair Janet Yellen told Congress in July that By Kathy Jones there have been some “false dawns” over the past few years, so the path to higher interest rates is by no means carved in stone.) conomists don’t like to place too much Any further signs of life in the economy emphasis on any single piece of data, would probably mean additional price declines E but the Labor Department’s Consumer for bonds as investors position themselves Price Index report for May certainly grabbed for a rate hike. Given these conditions, bond their attention. Consumer prices, as tracked investors may need to consider new strategies by the index, posted their sharpest gains in for dealing with shifting markets. more than a year that month, pushing the annual rate of inflation to 2.1%.1 Strategies to consider The market’s reaction to the report was One alternative for investors who are thinking swift: Investors sold short-dated government about making tactical moves in anticipation bonds, sending their yields to fresh highs for of rising rates is what’s commonly called a the year. The perception was that after months “barbell strategy.” This approach involves of only moderate gains in prices, inflation concentrating the maturities in a bond had bottomed out and was starting to rise— portfolio at the shorter and longer ends of possibly even fast enough for the Federal the spectrum. Reserve to consider raising interest rates before Here’s how it works: Bonds maturing in 2015, when the market was expecting the hike. the short-term portion of the portfolio deliver The Fed maintains a 2% target for inflation, proceeds that can be reinvested in newly issued and price growth above that level could prompt short-term securities, giving an investor the the central bank to intervene to head off the flexibility to immediately take advantage of any possibility of the economy overheating. rise in short-term interest rates. Meanwhile, Just a few months earlier, the situation bonds in the longer-term portion of the looked very different to bond investors. At the portfolio, which tend to offer higher yields, International Monetary Fund (IMF) meeting deliver steady income. in Washington, D.C., in April, finance officials The idea is that by constantly rolling from around the world expressed concern over short-maturity bonds while avoiding about disinflation—a slowing in the pace of intermediate-term ones, an investor can inflation—and wondered whether it was a manage his or her exposure to the big possible precursor to deflation, a sustained price swings likely to hit the short- to fall in the general price level of goods and intermediate-term portion of the yield services. Such concerns had dragged long- curve when rates rise. term bond yields lower. The barbell strategy is far from a perfect Fixed income investors might be forgiven solution, since yields are still low across the for feeling a little seasick, but in times like yield curve and a rise in rates could have a these, a bit of long-term perspective can help negative impact on the overall portfolio by steady the horizon. It’s unwise to draw too many conclusions from one month’s worth of 1Bureau of Labor Statistics, Consumer Price Index Summary, 7/17/2014. pricing data. Other pricing reports favored by 2Ben Leubsdorf, “U.S. Consumer Spending Rises 0.5% in August,” the Fed—such as the Commerce Department’s See page 2 for important information. personal consumption expenditures deflator— Past performance is no guarantee of future results. 2 recorded inflation of less than 2% in August. ©John Kuczala (1114-4735)

12 Charles schwab • W i n t e r 2 014

OI-Wi14-Q4-12 dOI_Wi14_12-13_PER_Jones.indd 12 10/2/14 12:04 PM And in Europe and other parts of the world, pushing down prices, but it does offer a way to disinflation is still a real concern, even if inflation limit exposure to shorter-term price volatility. has reached a turning point here at home. Long-term investors who don’t take All things considered, it’s probably safe for such a tactical approach could consider a fixed income investors to assume that, unless laddered strategy. This involves spreading growth falters, short-term rates will move bond purchases evenly across a variety of What this year’s price signals higher eventually. (It’s worth noting that Fed maturities and then reinvesting the proceeds mean for bond investors. Chair Janet Yellen told Congress in July that from maturing bonds in longer-term ones. To there have been some “false dawns” over the help increase the income from the portfolio past few years, so the path to higher interest as interest rates rise, investors following this rates is by no means carved in stone.) strategy may want to extend their portfolio’s conomists don’t like to place too much Any further signs of life in the economy average duration—the amount of time it takes emphasis on any single piece of data, would probably mean additional price declines for the cash flows from a bond to cover its but the Labor Department’s Consumer for bonds as investors position themselves purchase price. Again, it’s worth remembering Price Index report for May certainly grabbed for a rate hike. Given these conditions, bond that an interest rate increase will affect all parts their attention. Consumer prices, as tracked investors may need to consider new strategies of a bond portfolio. by the index, posted their sharpest gains in for dealing with shifting markets. more than a year that month, pushing the Don’t chase yield annual rate of inflation to 2.1%. Strategies to consider Barbell and ladder strategies are preferable to The market’s reaction to the report was One alternative for investors who are thinking chasing yield by investing in riskier segments swift: nI vestors sold short-dated government about making tactical moves in anticipation of the bond market. Valuations for some of bonds, sending their yields to fresh highs for of rising rates is what’s commonly called a these segments, such as high-yield bonds and the year. The perception was that after months “barbell strategy.” This approach involves bonds from debt-laden European countries, of only moderate gains in prices, inflation concentrating the maturities in a bond are stretched by historical standards, reflecting had bottomed out and was starting to rise— portfolio at the shorter and longer ends of the demand for yield. (For more, see “Worth possibly even fast enough for the Federal the spectrum. the Risk?” on page 27.) As 2015 and the Reserve to consider raising interest rates before Here’s how it works: Bonds maturing in prospect of a U.S. rate hike get closer, some “It is probably 2015, when the market was expecting the hike. the short-term portion of the portfolio deliver pullback is likely. safe for The Fed maintains a 2% target for inflation, proceeds that can be reinvested in newly issued Even though it seems unlikely that short- fixed income and price growth above that level could prompt short-term securities, giving an investor the term rates will rise quickly, just the indication investors to the central bank to intervene to head off the flexibility to immediately take advantage of any that they’re going to be “unanchored” from possibility of the economy overheating. rise in short-term interest rates. Meanwhile, zero some time down the road could cause assume that, Just a few months earlier, the situation bonds in the longer-term portion of the the yield chasers to run for cover. It’s probably unless growth looked very different to bond investors. At the portfolio, which tend to offer higher yields, best to avoid being caught in the crowd, as falters, short- International Monetary Fund (IMF) meeting deliver steady income. that’s the kind of excitement in the bond term rates will in Washington, D.C., in April, finance officials The idea is that by constantly rolling market that we like to avoid. - move higher from around the world expressed concern over short-maturity bonds while avoiding eventually.” about disinflation—a slowing in the pace of intermediate-term ones, an investor can Kathy Jones is Vice President, Fixed inflation—and wondered whether it was a manage his or her exposure to the big Income Strategist at the Schwab Center possible precursor to deflation, a sustained price swings likely to hit the short- to for Financial Research. fall in the general price level of goods and intermediate-term portion of the yield services. Such concerns had dragged long- curve when rates rise. Call Us term bond yields lower. The barbell strategy is far from a perfect For help with your bond Fixed income investors might be forgiven solution, since yields are still low across the investments, call 866-893-6699 to for feeling a little seasick, but in times like yield curve and a rise in rates could have a spea k with a S chwab Fixed Income these, a bit of long-term perspective can help negative impact on the overall portfolio by Specialist. steady the horizon. It’s unwise to draw too many conclusions from one month’s worth of 1Bureau of Labor Statistics, Consumer Price Index Summary, 7/17/2014. pricing data. Other pricing reports favored by 2Ben Leubsdorf, “U.S. Consumer Spending Rises 0.5% in August,” The Wall Street Journal, 9/29/2014. the Fed—such as the Commerce Department’s See page 2 for important information. personal consumption expenditures deflator— Past performance is no guarantee of future results. recorded inflation of less than 2% in August. ©John Kuczala (1114-4735)

Winter 2014 • on investing 13

OI-Wi14-Q4-13 dOI_Wi14_12-13_PER_Jones.indd 13 10/8/14 9:19 AM Perspectives: taxes

A Tax-Smart Approach to Your Cost Basis Understanding the tax rules may help you keep more of your gain. By Rande Spiegelman

hen it comes to calculating your make adjustments to account for events that For example, say you buy 100 shares of capital gains tax, understanding affect the per-share price of a stock, such as a stock for $50 each, and a year later buy W your cost basis is crucial. mergers, stock splits and spinoffs. 100 more at $60 each. By the following Essentially, the cost basis of an investment is Your adjusted cost basis should also reflect year, the stock is trading at $80 and you what you paid for it. Working out any capital reinvested dividends or distributions from sell 50 shares. Your capital gain will gains when you sell an investment is just a mutual funds and exchange-traded funds differ depending on which shares—those matter of subtracting your cost basis from (ETFs). Why? The IRS treats reinvested purchased for $50 or $60—you sell. your sale price. It sounds simple enough, but dividends as if the money had been distributed Let’s look at two common accounting “It’s not what calculating your cost basis can be complex— directly to you, meaning distributions in a options for such cases. you make but and if you do it incorrectly, you could end up taxable account will be reported on a 1099-DIV -- what you keep paying the wrong amount in taxes. form and taxed as regular dividend income. Adjusting your cost basis ensures you won’t that counts.” Adjusting your cost basis also pay capital gains taxes on those funds. You can adjust your original purchase price Imagine you invest $10,000 in a stock that for a variety of reasons. When you buy stocks, pays out $200 in taxable dividends, which for example, you typically calculate your initial you automatically reinvest. That gives you an cost basis by adding commissions and fees to initial cost basis of $10,000 and an adjusted your per-share purchase price. You can also cost basis of $10,200. Now, imagine the value of your stock rises to $10,500 and you sell your holdings. -- Using your original cost basis instead of the adjusted one would result in a bigger capital Original $10,500 Sale price $10,500 Sale price vs. gain—and therefore a higher tax bill. Original Adjusted - $10,000 cost basis - $10,200 adjusted cost basis cost basis Know your accounting method $500 Capital gain $300 Capital gain Another complication arises if you’ve purchased the same security on multiple

occasions at a variety of prices. ©John Kuczala

14 Charles schwab • W i n t e r 2 014

OI-Wi14-Q4-14 dOI_Wi14_14-16_PER_Spiegelman.indd 14 10/14/14 10:02 AM make adjustments to account for events that For example, say you buy 100 shares of affect the per-share price of a stock, such as a stock for $50 each, and a year later buy Accounting Sale Purchase Gain/ Shares Total mergers, stock splits and spinoffs. 100 more at $60 each. By the following method price price share sold gain Your adjusted cost basis should also reflect year, the stock is trading at $80 and you reinvested dividends or distributions from sell 50 shares. Your capital gain will FIFO ($80 – $50) = $30 × 50 = $1,500 mutual funds and exchange-traded funds differ depending on which shares—those (ETFs). Why? The IRS treats reinvested purchased for $50 or $60—you sell. Specific dividends as if the money had been distributed Let’s look at two common accounting identification ($80 – $60) = $20 × 50 = $1,000 directly to you, meaning distributions in a options for such cases. taxable account will be reported on a 1099-DIV -- First in, first out (FIFO): This is the form and taxed as regular dividend income. IRS’s default accounting method. For Adjusting your cost basis ensures you won’t partial sales, the IRS presumes you’re There are other accounting methods out there. also pay capital gains taxes on those funds. selling the oldest shares first, which can Investors may want to discuss their options with Imagine you invest $10,000 in a stock that lead to a larger capital gain if the oldest a tax professional before selling an investment. pays out $200 in taxable dividends, which shares have appreciated more than those you automatically reinvest. That gives you an acquired later. In the example above, Reporting your cost basis initial cost basis of $10,000 and an adjusted that would mean selling your $50 shares Your brokerage firm lists the proceeds of sales cost basis of $10,200. Now, imagine the value first, resulting in a capital gain of $30 per in your taxable account on Form 1099-B. It of your stock rises to $10,500 and you sell share, or $1,500 in total. may also report your adjusted cost basis, but your holdings. -- Specific identification: This method this will depend on when you bought the asset. Using your original cost basis instead of the allows you to identify which shares Policy reforms introduced after the financial adjusted one would result in a bigger capital you’re selling at the time of the sale. It crisis require banks and brokerages to report gain—and therefore a higher tax bill. is more flexible than FIFO and gives adjusted cost basis for: you the opportunity to optimize results. -- Stocks bought after 2010 For our hypothetical portfolio, you -- Mutual funds, ETFs and dividend could choose to sell the $60 shares first, reinvestment plans bought after 2011 resulting in a capital gain of $20 per -- Other specified securities, including most

©John Kuczala share, or $1,000 in total. fixed income securities, acquired after 2013

Winter 2014 • on investing 15

OI-Wi14-Q4-15 dOI_Wi14_14-16_PER_Spiegelman.indd 15 10/14/14 10:02 AM PERSPECTIVES: TAXES Tracking your cost basis You can check the cost basis of your Schwab portfolio on schwab.com. Under the Accounts tab, click on “Positions” and then navigate to the Unrealized Gain/Loss tab. The image below shows a hypothetical portfolio:

Market Value Positions Monitor Whether your cost basis is reported to the Trades made today will not appear until tomorrow. IRS or not, you are ultimately responsible for the information on your tax return, so you should save your original purchase and sale documentation. For mutual funds, that GENERAL ELECTRIC CO includes statements showing automatic SAMPLE reinvestments. When you sell a position, you can determine your cost basis by clicking on “Cost Basis Calculator” at the top right in the image above. Here is an You should also make sure your nancial example using one of the holdings in a hypothetical portfolio: institution is using the accounting method of your choice. If not, you may want to adjust it for future sales. Using the reporting rules to your advantage Usually, you want to minimize taxes by recognizing the smallest net gain (or largest loss) possible on your tax return. However, SAMPLE on occasion you might want to do the The Cost Basis Calculator allows you to look up a stock’s ticker symbol opposite. For example, you may decide to and price. Corporate actions such as name changes, splits and spinoffs recognize a larger gain if you can o set it going back to 1950 are automatically refl ected in a position’s cost basis. with a current loss or capital-loss carryovers You can also include reinvested dividends going back to 1973 and factor from previous tax years. in your tax rate. Remember, it’s not what you make but When you’re ready to calculate, click the Analyze button to receive a what you keep that counts. If you’re tax-smart report showing realized gains or losses and applicable taxes. about calculating and reporting the cost basis of your investments, you may be able to hold on to more of your return. Be sure to check with your tax advisor before entering into any transaction that may have signi cant tax consequences. -

Rande Spiegelman, CPA, CFP ®, is Vice President of Financial Planning at the Schwab Center for Financial Research.

NEXT STEPS SAMPLE For more information about cost basis reporting, including a schedule of when you can expect to receive your 2014 tax forms from Schwab, log in to schwab.com/OItax.

Examples are hypothetical and not representative of any specifi c investment or situation. Individual stock positions are for illustrative purposes only and are not a recommendation or solicitation to See page 2 for important information. buy or sell. There is no guarantee that positions would have been or may be profi table. (1114-4774)

16 CHARLES SCHWAB • W I N T E R 2 014

OI-Wi14-Q4-16 dOI_Wi14_14-16_PER_Spiegelman.indd 16 10/8/14 9:19 AM dOI_Wi14_17-19_Trading_b.indd 17

©Getty Images still have questions become, D By Michael ETFs. trading about questions top to Answers “As widelyused as ETFs have as ETFs have about them.” emystifying traders I achini OI-Wi14-Q4-17

E common ones. about Here them. are some of most the havethough, traders still questions just about any trading strategy. variety means there’s likely an ETF to suit hold assetslike commodities. This sheer indexes of stocks or bonds, some ETFs can liquidity. And although most ETFs track like generally stocks, offer they exceptional much funds trade reason. these Because As as widely ETFs have used become, traders’ portfolios, and for good occupy acentral place inmany xchange-traded funds (ETFs) ET F Q stocks could deliver vastly different returns. example, two ETFs tracking tech industry individual ETFs inmost other categories. For significantcan be differences the between all, ar all, pretty tooneanother? similar inagiv performer 500 benchmark, particular such as S&P the A T ® : : Index, performsimilarly. will But there radin en’t the en’t

tracking performance the of a Not really. Ofcourse, two ETFs I When usually just pick the top usuallyjustpickthetop Winter 2014 Winter • I invest inan ET Fs inacategory en category. on investing g ET F, A

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T rading 10/2/14 12:06PM 17 Trading

The table below looks at why the price, the idea being that when large with a price difference of $0.05 per it rose on the first day because of the holdings of the ETFs within a given quantities of ETFs are changing hands, share. That’s a spread of 0.25%, which extra inverse exposure it took on. category might differ. It also shows there might be more chances to buy at isn’t nearly as good. What’s the bottom line? Over how this can lead to varying outcomes. a lower price or sell at a higher one. In general, you probably want to periods longer than a day, inverse ETFs As you can see, it’s important to However, when searching for a good avoid ETFs that have a spread greater might not return the opposite of what research potential ETF selections to price, I think it makes more sense to look than 0.25%. However, the longer the index returns. They are intended ensure they provide the exposure you at the bid-ask spread, or the gap between you hold an ETF, the less important for very active traders and should be actually want. To do this, you can go to the best price at which you can buy an spread becomes. monitored as frequently as daily. schwab.com and enter an ETF ticker ETF and the best price at which you can There are other ways to achieve your symbol. Then go to the Portfolio tab, sell it. Think of the bid-ask spread as one Should I use inverse ETFs to hedging goals. Call us at where you can see the ETF’s portfolio of the costs of trading, separate from Q: hedge my portfolio? to talk about them. characteristics. fees and commissions. The smaller the spread, the smaller the cost. If you choose to use them, do Market volatility was How much does average You should also think about the A: so very, very carefully. Inverse Q: particularly low earlier Q: volume matter when bid-ask spread as a percentage rather ETFs are designed to go up when the this year. want to bet that trading an ETF? than a cost per share. To see why, market goes down and down when the volatility will pick up again soon, imagine you’re trading a $100 ETF market goes up. They are often used does it make sense to buy Not as much as you might and the difference between the bid and to make very short-term tactical bets V A: think. Some traders look at ask prices is $0.05 per share. That’s a against the market, and they can also average volume to determine how easy spread of 0.05%, which is pretty good. be used for hedging purposes. The VIX is a market volatility it will be to trade an ETF at a good Now imagine you’re trading a $20 ETF For instance, imagine that you A index published by the believe a particular stock is likely to Chicago Board Options Exchange. outperform its peers, whether the It is tied to the amount of volatility sector goes up or down in value. In traders expect to see in the S&P How ETFs in the same category might differ this scenario, you could buy $5,000 500 over the next month and is worth of the stock and $5,000 worth sometimes called the “fear index” Differentiating factors Examples of returns of an inverse ETF tied to the stock’s since it tends to go up when market sector. Let’s assume that you’re right, participants panic. Weighting: Two ETFs in the same Morningstar category: and the stock outperforms its sector You can’t buy individual stocks category might use different U.S. large blend by 2%. If the stock rises by 6% while to mirror the VIX’s movements. As methods for calculating the weights --One-year average return for the sector rises by 4%, your combined a result, VIX ETFs own baskets of of the components they hold. equal-weighted funds: 16.6% investment would be expected to rise futures contracts tied to the future Weights can be determined by --One-year average return for by 2%. Similarly, if the stock falls by 7% level of the VIX and are designed to market capitalization (the most volatility-weighted funds: 13.5% while the sector falls by 9%, your total rise when volatility-wary investors common methodology), economic investment would also rise by 2%. Of drive up the prices of such derivatives. variables, dividends, volatility or course, if you’re wrong and your stock For this reason, you might think other characteristics. underperforms the sector, you would that a VIX ETF could provide portfolio likely lose money regardless of whether insurance. But that would be a mistake. Market segment: Two ETFs Morningstar category: Health the stock goes up or down in value. At issue is a characteristic affecting within a particular category --One-year average return for The situation becomes trickier futures known as “contango.” might focus on different subsectors pharmaceutical funds: 27.1% when we factor in “beta slippage.” This In a nutshell, contango occurs or industries. --One-year average return for health refers to the effects that arise from when a longer-dated futures contract care equipment funds: 19.1% ETFs having to adjust their holdings to costs more than one that is about to reflect changes in the market. expire. This poses a major problem Bond duration: Two bond ETFs Morningstar category: For example, if the index your for VIX-linked ETFs because when within a single category might focus Corporate bond inverse ETF is tracking falls by 1% on a they are trading in contango they on different durations. Duration --One-year average return for long given day, the ETF should rise by about must constantly buy longer-dated, measures the amount of time it duration funds: 12.2% 1%, at which point it will need to buy higher-cost futures to replace the takes for the cash flows from a bond --One-year average return for short more inverse exposure to reflect its cheaper contracts that are expiring. to cover its purchase price. duration funds: 2.3% larger total asset base. If on the next day In other words, they must repeatedly the index rises back to where it started, buy high and sell low—not a recipe Source: Morningstar, as of 7/31/2014. the ETF will drop by slightly more than for success. And this doesn’t even take

18 Charles schwab • W i n t e r 2 014

OI-Wi14-Q4-18 dOI_Wi14_17-19_Trading_b.indd 18 10/2/14 12:06 PM with a price difference of $0.05 per it rose on the first day because of the share. That’s a spread of 0.25%, which extra inverse exposure it took on. Value of $10,000 in VIX and VIX futures contracts isn’t nearly as good. What’s the bottom line? Over In general, you probably want to periods longer than a day, inverse ETFs Here’s what $10,000 would be worth if it had been invested in a hypothetical VIX index, a portfolio of short-term VIX futures contracts or a portfolio of medium-term VIX futures avoid ETFs that have a spread greater might not return the opposite of what contracts. These portfolios are based on actual ETFs that buy VIX futures contracts. than 0.25%. However, the longer the index returns. They are intended you hold an ETF, the less important for very active traders and should be $25k spread becomes. monitored as frequently as daily. $20k There are other ways to achieve your hedging goals. Call us at 888-484-5340 $15k to talk about them. $10k

$5k If you choose to use them, do Market volatility was so very, very carefully. Inverse Q: particularly low earlier 0

11 11 11 11 11 11 12 12 12 12 12 12 13 13 13 13 13 13 14 ETFs are designed to go up when the this year. If I want to bet that ’ n ’ r ’ y ’ n ’ r ’ y ’ n ’ r ’ y ’ n ’ a a a a a a a a a Jul volatility will pick up again soon, J sep ’ J Jul ’ sep ’ J Jul ’ sep ’ nov ’ J market goes down and down when the M M nov ’ ma M nov ’ M M does it make sense to buy market goes up. They are often used Short-Term VIX Futures Portfolio Medium-Term VIX Futures Portfolio VIX Index to make very short-term tactical bets VIX®-based ETFs? against the market, and they can also be used for hedging purposes. The VIX is a market volatility Source: Morningstar, as of 2/28/2014. The example shown above is hypothetical and is provided for illustrative For instance, imagine that you : index published by the purposes only, and is not representative of any specific investment or trade. Fees in this example differ and can affect A performance. Past performance is no guarantee of future results. believe a particular stock is likely to Chicago Board Options Exchange. outperform its peers, whether the It is tied to the amount of volatility sector goes up or down in value. In traders expect to see in the S&P into account the transaction costs Michael Iachini is Managing Director this scenario, you could buy $5,000 500 over the next month and is involved in this process, which also of Mutual Fund and ETF Research at worth of the stock and $5,000 worth sometimes called the “fear index” reduce returns. Charles Schwab Investment Advisory, Inc. of an inverse ETF tied to the stock’s since it tends to go up when market So, if you want to bet on a very sector. Let’s assume that you’re right, participants panic. short-term jump in market volatility, and the stock outperforms its sector You can’t buy individual stocks a VIX ETF might go up in value if Next Steps by 2%. If the stock rises by 6% while to mirror the VIX’s movements. As you’re right. But if you plan to hold a Stay abreast of the markets with the sector rises by 4%, your combined a result, VIX ETFs own baskets of VIX ETF for a longer period of time, Traders Lunch, a live analysis investment would be expected to rise futures contracts tied to the future be aware of the eroding power of and Q&A session about current by 2%. Similarly, if the stock falls by 7% level of the VIX and are designed to contango in VIX futures contracts, market action. Join us every while the sector falls by 9%, your total rise when volatility-wary investors as illustrated in the chart above. You Thursday at 1:30 p.m. Eastern investment would also rise by 2%. Of drive up the prices of such derivatives. should note that, since mid-2006, time. Sign up at schwab.com/ course, if you’re wrong and your stock For this reason, you might think VIX futures have traded in contango OItraderslunch. underperforms the sector, you would that a VIX ETF could provide portfolio 78% of the time.1 - likely lose money regardless of whether insurance. But that would be a mistake. the stock goes up or down in value. At issue is a characteristic affecting 1Bloomberg, with data from 8/31/2006–2/28/2014. The situation becomes trickier futures known as “contango.” when we factor in “beta slippage.” This In a nutshell, contango occurs See page 2 for important information. refers to the effects that arise from when a longer-dated futures contract Investors should carefully consider information contained in the prospectus, including investment ETFs having to adjust their holdings to costs more than one that is about to objectives, risks, charges and expenses. You can request a prospectus by visiting schwab.com or reflect changes in the market. expire. This poses a major problem calling Schwab at 800-435-4000. Please read the prospectus carefully before investing. For example, if the index your for VIX-linked ETFs because when Past performance is no guarantee of future results. inverse ETF is tracking falls by 1% on a they are trading in contango they Inverse ETFs seek to provide the opposite of the investment returns, daily, of a given index or benchmark, either in whole or by multiples. Due to the effects of compounding, aggressive techniques, and possible correlation errors, inverse ETFs may given day, the ETF should rise by about must constantly buy longer-dated, experience greater losses than one would ordinarily expect. Compounding can also cause a widening differential between 1%, at which point it will need to buy higher-cost futures to replace the the performances of an ETF and its underlying index or benchmark, so that returns over periods longer than one day can more inverse exposure to reflect its cheaper contracts that are expiring. differ in amount and direction from the target return of the same period. Consequently, these ETFs may experience losses even in situations where the underlying index or benchmark has performed as hoped. Aggressive investment techniques larger total asset base. If on the next day In other words, they must repeatedly such as futures, forward contracts, swap agreements, derivatives and options can increase ETF volatility and decrease the index rises back to where it started, buy high and sell low—not a recipe performance. Investors holding these ETFs should therefore monitor their positions as frequently as daily. the ETF will drop by slightly more than for success. And this doesn’t even take (1114-4736)

Winter 2014 • on investing 19

OI-Wi14-Q4-19 dOI_Wi14_17-19_Trading_b.indd 19 10/2/14 12:06 PM Capitalizing on Global Real Estate Consider overseas property investments

to balance your portfolio. ©Getty Images

20 Charles schwab • W i n t e r 2 014

OI-Wi14-Q4-20 dOI_Wi14_20-23_FT_Real_Estateb.indd 20 10/8/14 4:49 PM he potential bene ts of investing in real one expect from owning multiple properties in the same estate extend beyond the comfort of having a neighborhood, city or even country? roof over your head.  at’s why it might make sense to think on a global As an asset class, real estate can complement scale, says Tony Davidow, Vice President of Alternative Beta a traditional portfolio of stocks, bonds and and Asset Allocation Strategist at the Schwab Center other nancial products. Some of the key for Financial Research. Tbene ts of investing in real estate include: Historically, global real estate has delivered strong CAPITALIZING - Growth potential. Real estate holdings can grow in performance and attractive returns. And having exposure value over time, potentially delivering capital gains. to a portfolio of real estate holdings allocated across - Income potential. Real estate has historically provided regions could offer investors not only international attractive income to investors, whether in the form of diversi cation, but also another way to participate in REAL ESTATE rental income or dividends and other distributions. global economic growth. - Diversifi cation. Including real estate in your “Real estate can be an e ective barometer of the state of portfolio could o er another way to further diversify the economy,” Tony says. “Rising real estate prices and rents your holdings. could indicate strong demand and a healthy economy, while falling prices may portend trouble.” Consider overseas property investments  is last point raises an important question: When it Let’s take a closer look at how growth potential, income comes to real estate investing, how broad should investors’ potential and diversi cation bene ts could make global real to balance your portfolio. ©Getty Images horizons be? A er all, how much diversi cation can estate attractive to investors.

WINTER 2014 • ON INVESTING 21

OI-Wi14-Q4-21 dOI_Wi14_20-23_FT_Real_Estateb.indd 21 10/8/14 4:49 PM In fact, the United States and Europe accounted for a “Global real estate combined 48.7% share of global gross domestic product securities have compared (GDP) in 2012, down from 60.7% in 2000. During the same period, Asia and Latin America’s combined share of favorably to other asset global GDP rose to 40.1% from 33.7%.1 “In other words, the growth outside of the United classes in recent years, States is likely to be stronger than the growth within our borders, supporting the case for a global allocation,” performing nearly as well Tony says. as U.S. stocks even as Attractive income global equities lagged.” On top of offering growth potential, global real estate 2 investment trusts (REITs) have historically provided attractive yields relative to equities and many fixed income Strong growth potential options. As of the end of June 2014, global REITs were Global real estate securities have compared favorably yielding 3.5%, which compares favorably with the 3.4% 1to other asset classes in recent years, as you can see in yield on international stocks and 1.9% yield on U.S. stocks.2 the chart below. “With fixed income yields at generationally low levels, “A global allocation could also be a means of gaining investors have been seeking other sources of income and exposure to emerging economies, whose share of global REITs have been an attractive option,” Tony says. economic output has been increasing in recent years as Of course, higher yields could also mean increased growth rates have picked up,” says Tony. “Many economists risks, so income investors should use caution when Source: Morningstar Direct. Asset classes are represented by the following indexes: broad U.S. stock market: S&P 500 Index; U.S. small-cap stocks: Russell 2000 Index; international stocks: MSCI EAFE Index; global stocks: are predicting stronger international growth in coming considering global REITs for their income needs. (For MSCI Word Index; investment-grade bonds: Barclays U.S. Aggregate Bond Index; commodities: Dow Jones-UBS years, particularly in Asia and Latin America.” more, read “Worth the Risk?” on page 27.) Commodity Index; global real estate: FTSE EPRA/NAREIT Global Real Estate Index.

In 2006, 2009 and 2012, global real estate was the best Global real estate outpaces global securities 3 performer out of seven major asset classes, as shown in the chart above. Conversely, it was the worst performer in 20k 2007 and 2008. There is a natural rotation among the best- and worst- performing asset classes. By allocating across stocks, 15k bonds, commodities and real estate, investors gain diversified exposure—and global investments amplify that diversification potential. “Global real estate provides exposure to various parts of 10k the globe, and has historically delivered strong performance, attractive yields and diversification benefits relative to traditional investments,” says Tony. 5k 1Prudential Real Estate Investors, “Why Global Real Estate Securities?” 2013. 2FactSet and Bloomberg data as of 6/30/2014. U.S. stocks are represented by the S&P 500 Index. International stocks are represented by the MSCI EAFE Index. 0 See page 2 for important information. 2006 2007 2008 2009 2010 2011 2012 2013 2014 Investors should carefully consider information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by visiting schwab.com or calling Schwab at 800-435-4000. Please read the prospectus carefully before investing. F T S E E P R A/ N A r e i t G l o b al I n d ex MSC I E AF E I n d ex S & P 5 0 0 I n d ex Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Unlike mutual funds, shares of ETFs are not individually redeemable directly with the ETF. Shares are bought and sold at market price, which may be Source: Morningstar Direct with data from 2/22/2005–6/30/2014. FTSE EPRA/NAREIT Global Index was incepted on 2/22/2005. The example is higher or lower than the net asset value. hypothetical and provided for illustrative purposes only. It is not intended to represent a specific investment or product. Dividends and interest are assumed to have been reinvested, and the example does not reflect the effects of expenses, taxes or fees. If it had, performance would have been Past performance is no guarantee of future results.

substantially lower. Past performance is no guarantee of future results. ©Getty Images (1114-4880)

22 Charles schwab • W i n t e r 2 014

OI-Wi14-Q4-22 dOI_Wi14_20-23_FT_Real_Estateb.indd 22 10/8/14 9:31 AM Comparing asset class performance 50% rns etu

r 0 Ways to Invest l l a On top of offering growth potential, global real estate u

nn in Real Estate

investment trusts (REITs) have historically provided A attractive yields relative to equities and many fixed income Investors can simply buy property— options. As of the end of June 2014, global REITs were ranging from a second home or condo yielding 3.5%, which compares favorably with the 3.4% to something as large as a shopping yield on international stocks and 1.9% yield on U.S. stocks.2 -50% mall or office building—in the United States and in many overseas countries. “With fixed income yields at generationally low levels, 2006 2007 2008 2009 2010 2011 2012 2013 However, such purchases could investors have been seeking other sources of income and Global real estate Investment-grade bonds Commodities U.S. small International stocks Broad U.S. stock market Global stocks cap stocks involve challenges such as hefty down REITs have been an attractive option,” Tony says. payments, maintenance obligations Of course, higher yields could also mean increased and restrictive foreign ownership laws, risks, so income investors should use caution when Source: Morningstar Direct. Asset classes are represented by the following indexes: broad U.S. stock market: S&P 500 Index; U.S. small-cap stocks: Russell 2000 Index; international stocks: MSCI EAFE Index; global stocks: not to mention the cost of traveling to considering global REITs for their income needs. (For MSCI Word Index; investment-grade bonds: Barclays U.S. Aggregate Bond Index; commodities: Dow Jones-UBS check on the property. more, read “Worth the Risk?” on page 27.) Commodity Index; global real estate: FTSE EPRA/NAREIT Global Real Estate Index. A REIT is a special type of corporation that invests in real Diversification estate properties, mortgages or both. In 2006, 2009 and 2012, global real estate was the best REITs trade on major exchanges like stocks and many are required to performer out of seven major asset classes, as shown in 3 distribute a portion of their income the chart above. Conversely, it was the worst performer in Next Steps to shareholders as dividends. REITs 2007 and 2008. offer a variety of diverse investing There is a natural rotation among the best- and worst- The new Schwab Fundamental Global styles. Some invest in property in performing asset classes. By allocating across stocks, Real Estate Index specific geographic regions, while bonds, commodities and real estate, investors gain Fund is a simple way others are widely diversified. Some diversified exposure—and global investments amplify that to gain diversification REITs specialize in property types, diversification potential. and income potential. such as office buildings, shopping “Global real estate provides exposure to various parts of Learn more on page 31 malls, apartments, warehouses, the globe, and has historically delivered strong performance, or at schwab.com/ hotels or a combination of properties. attractive yields and diversification benefits relative to OIglobalrealestate. A traditional investments,” says Tony. - real estate operating company (REOC) is like a REIT in that it is a corporation that owns real estate 1 Prudential Real Estate Investors, “Why Global Real Estate Securities?” 2013. and trades like a stock. However, 2FactSet and Bloomberg data as of 6/30/2014. Global REITs are represented by the FTSE EPRA/NAREIT Global Real Estate Index. U.S. stocks are represented by the S&P 500 Index. International stocks are represented by the MSCI EAFE Index. REOCs don’t have to distribute their cash flow to investors, leaving them See page 2 for important information. free to invest their holdings in other Investors should carefully consider information contained in the prospectus, including investment properties or improvements. objectives, risks, charges and expenses. You can request a prospectus by visiting schwab.com or calling Schwab at 800-435-4000. Please read the prospectus carefully before investing. Mutual funds and exchange-traded Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when funds (ETFs) that invest in REITs redeemed or sold, may be worth more or less than their original cost. Unlike mutual funds, shares of ETFs are or REOCs can provide diversified not individually redeemable directly with the ETF. Shares are bought and sold at market price, which may be exposure across a variety of sectors higher or lower than the net asset value. and regions. Past performance is no guarantee of future results.

©Getty Images (1114-4880)

Winter 2014 • on investing 23

OI-Wi14-Q4-23 dOI_Wi14_20-23_FT_Real_Estateb.indd 23 10/9/14 1:24 PM Giving Wisely Make the most of your charitable DONATIONS by thinking strategically.

For many people, the end of the year signifies a time of giving—not just to family and friends, but to charitable organizations as well. On average, charities receive about 40% of their total donations during the final weeks of the year.1 The annual tide of goodwill helps organizations direct funding, set their budgets for the coming year, and hire or retain employees. As meaningful as year-end contributions can be, many individual donors have discovered that they can optimize their giving throughout the year with donor- advised funds. These charitable vehicles—tax-advantaged accounts to which you can contribute cash, securities, real estate, art and other valuables for eventual distribution to charities—offer a number of advantages over traditional direct giving. One of the main attractions of donor-advised funds is their flexibility. Donors can contribute to the account at any time—and claim an immediate tax deduction—but can take a more strategic approach regarding when and how

to distribute the gifts. For example, an individual might ©Getty Images

24 Charles schwab • W i n t e r 2 014

OI-Wi14-Q4-24 dOI_Wi14_24-26_FT_Charitable_3.indd 24 10/2/14 12:11 PM make several tax-deductible donations to a donor-advised fund account throughout the year as part of a plan to give a large, one-time gift to an organization later in life. In addition, contributing appreciated securities or other assets to a donor-advised fund—instead of selling first and then donating the proceeds to a charity—can help you avoid paying capital gains taxes on those assets and enable more money to go to charity. As you can see from the example in the table below, thinking strategically about donations could boost the value of those donations as well as deliver attractive tax benefits. Schwab Charitable President Kim Laughton says donors are increasingly sensitive to the fact that while giving is always good, giving wisely is great. “Charitable planning is becoming a natural part of financial planning and wealth management discussions,” she says. Regardless of how you give—directly to charities, through a donor-advised fund or via another method— it may be possible to increase the impact of your contributions. Here are five tips for creating a strategic plan for your charitable giving. >

Tax benefits of donating cash vs. stock

Scenario 1: Scenario 2: Sell appreciated stock Donate appreciated and donate proceeds stock directly to (cash) to charity donor-advised fund

Fair market value (FMV) $100,000 $100,000 $50,000 Capital gains tax appreciation (CGT) paid × 15% = $7,500 $0 Total donated $100,000 to charity – $7,500 (FMV – CGT) = 92,500 $100,000 $92,500 $100,000 Charitable tax × 28% × 28% deduction (CTD) = $25,900 = $28,000

Net tax savings $25,900 (CTD – CGT) – $7,500 = $18,400 $28,000

Hypothetical example is provided for illustrative purposes only. Assumes that the investment has been held for more than a year, donor is in the 28% federal income tax bracket, and that all realized gains are subject to a 15% federal long-term capital gains tax rate. Does not take into account any state or local taxes. Certain federal income tax deductions, including the charitable contribution, are available only to taxpayers who itemize deductions, and may be subject to reduction for taxpayers with adjusted gross income (AGI) above certain levels. In addition, deductions for charitable contributions may be limited based on the type of property donated, the type of charity and the donor’s AGI. For example, deductions for contributions of appreciated property to public charities generally are limited to 30% of the donor’s AGI. Excess contributions may be carried forward for up to five years. Total donor ©Getty Images tax savings are calculated by subtracting any long-term capital gains paid from the value of the charitable income tax deduction.

Winter 2014 • on investing 25

OI-Wi14-Q4-25 dOI_Wi14_24-26_FT_Charitable_3.indd 25 10/2/14 12:11 PM DEVELOP A PURPOSE. When defining your 1 purpose, start by asking yourself which specific causes you would like to support. You should also identify specific charitable goals before making any grants. Giving through In addition to reflecting your values, having clear goals can help you say no when you get solicitations to support Schwab Charitable projects that aren’t in line with your desired outcomes. You can open a Schwab Charitable donor-advised fund with CHOOSE ORGANIZATIONS TO SUPPORT. an initial deposit of $5,000 in cash or marketable securities. Once you’ve settled on a cause, it’s time to think We are also generally able to arrange for contributions of 2 other appreciated assets, such as real estate, private equity about which organizations you want to support. and other non-cash assets. As part of your research, consider contacting di erent Those assets can then be placed in a variety of organizations and asking questions.  eir answers could investment pools. For clients who would prefer to take help inform your decision. advantage of an existing strategy, Schwab Charitable offers You can conduct due diligence on charities through four pools following specially tailored, diversifi ed investment the IRS website or through your donor-advised fund. In approaches ranging from conservative to growth. Clients addition to verifying the organization’s 501(c)(3) status, who prefer to build their own allocations can spread their you might also consider analyzing its program results, contributions across a variety of single asset class pools.  nancials and sta turnover. Schwab Charitable will handle all due diligence surrounding the charities you recommend and will DECIDE ON GRANT TIMING AND AMOUNTS. distribute your grants on personalized letterhead. Additionally, you can use Once you identify speci c charities, you can grant 3 your mobile device to send money in one lump sum or spread it out over a timely grants to the charities span of months or years. Some charities prefer donations that mean the most to you. toward the end of their  scal year, which is generally when And you can access an To learn more about they draw up plans for the following year. With a donor- online summary of your grant Schwab Charitable or advised fund, you can create a giving schedule to make history by cause so that you to open an account, one-time or recurring donations. can monitor your activity and call 888-484-5340 ensure it is consistent with or visit schwab.com/ CHOOSE YOUR DESIRED LEVEL OF your giving plans. OIschwabcharitable. 4 RECOGNITION. Depending on the size of your charitable gi and the philanthropic vehicle you choose, the record of your donation could be made available to the public. For example, federal law requires private LEAVE A LASTING LEGACY. Consider adopting an foundations to report on their annual tax returns—which 5 estate-planning strategy to help pass down your are public records—the names of donors who give more charitable values along with your assets. With such than $5,000 in a single year. a strategy in place, your heirs will know which charitable With donor-advised funds, on the other hand, you can choose organizations to continue to support in your memory. how (or whether) you would like to be recognized for each A donor-advised account may make sense for people grant, giving you control over the amount of public exposure who want to create a legacy of giving for future generations, you receive for your donation.  ose who prefer to avoid without the administrative burden or cost of setting up a scrutiny or unwanted solicitations might opt for anonymity. private foundation. -

1Charity Navigator, “Year-End Giving Trends: 2013 Poll Results.” Contributions of certain real estate, private equity or other illiquid assets may be accepted via a charitable intermediary, with proceeds of your donation transferred to your donor-advised account upon liquidation. This intermediary considers donations on a case-by-case basis, and assets typically must be valued at $250,000 or more. Call Schwab Charitable for more information at 800-746-6216. Donors should carefully consider information contained in the prospectus for the mutual funds underlying the investment pools, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab Charitable at 800-746-6216. Please read the prospectus carefully before making contributions or recommending investment of funds. Market fl uctuations may cause the value of investment fund shares held in a donor-advised account to be worth more or less than the value of the original contribution to the funds. Schwab Charitable does not provide specifi c individualized legal or tax advice. Please consult a qualifi ed legal or tax advisor where such advice is necessary or appropriate. Schwab Charitable is the name used for the combined programs and services of Schwab Charitable Fund, an independent nonprofi t organization, and Schwab Charitable Trust Services, a limited liability company owned by Schwab Charitable Fund. The Fund has entered into service agreements with certain affi liates of The Charles Schwab Corporation. ©2014 Schwab Charitable Fund. All rights reserved. (1114-5555)

26 CHARLES SCHWAB • W I N T E R 2 014

OI-Wi14-Q4-26 dOI_Wi14_24-26_FT_Charitable_3.indd 26 10/9/14 1:26 PM Why preferreds, REITs and MLPs aren’t substitutes for bonds. ©Gina + Matt

WINTER 2014 • ON INVESTING 27

OI-Wi14-Q4-27 dOI_Wi14_27-29_FT_BondYields.indd 27 10/2/14 12:14 PM oming into 2014, many U.S. bond analysts were expecting a bond bear REIT A REIT is a special corporation that invests in real estate market—in which prices fall and yields rise—amid anticipation of an properties, mortgages or both. Some specialize in speci c improving economy and the winding down of the Federal Reserve’s property types such as shopping malls or o ce buildings, others invest in geographic regions, and some are bond-buying program. Such conditions would have been a welcome diversi ed and invest across property types, regions or both. Fixed income investors may be attracted to REITs relief for bond investors who have taken to the sidelines while they because they generally distribute a portion of their income wait for yields to rise. as dividends to shareholders. Such distributions helped push the average annualized total return on the Dow Jones Instead, U.S. bonds rallied in the fi rst half of the year, fueled largely by a U.S. Select REIT Index to 16.36% in the 2009–2013 period. Again, it is important to note that such returns come with lagging economy, dimmer housing prospects and stagnant job creation. added risk. Because REITs o en trade like stocks on major C Unrest in the Ukraine and Iraq also helped drive down yields as risk-averse exchanges, their prices can be volatile—of the eight asset classes compared in the chart at le , REIT prices exhibited investors gravitated toward the perceived safety of bonds. the highest risk during the 2009–2013 period. (For more on REITs, see “Capitalizing on Global Real Estate” on page 20.) The low-yield environment has encouraged some investors to consider substituting bonds with income-oriented investments, such as preferred securities, real estate investment trusts (REITs) MLP MLPs are a niche sector in the income world—most of and master-limited partnerships (MLPs). But where there is additional return or yield, there is usually them are oil and gas partnerships. MLPs trade like stocks on an exchange and distribute most of their cash  ow to unit added risk, as illustrated in the chart at right. holders, who are technically considered limited partners in the business. Returns on MLPs can be high—the Alerian MLP Let’s take a closer look at some of the potential Index had an average annualized total return of 29.55% during benefits and risks associated with preferred securities, Higher return tends to the 2009–2013 period. But these products also involve risks REITs and MLPs. coincide with higher risk and potential complications that must be weighed carefully. For example, distributions can be diluted if an MLP issues PREFERRED SECURITIES additional units to raise capital, and energy-linked MLPs MLPs  ese hybrid investments combine attributes of stocks 30% are sensitive to changes in fuel prices. Also, because MLPs and bonds.  ey tend to pay higher dividends than don’t pay corporate income taxes, unit-holders, as limited

common stock but have less growth potential because, 25% partners, pay income taxes on their share of the distributions. unlike common stock, they generally don’t increase in High-yield  is avoids the problem of double taxation that arises with corporates value if a company grows. As you can see in the chart, the 20% dividends, but it also means additional complexity when REITs average annualized total return on preferred securities Short Preferred ling taxes. And some income from MLPs may be subject to Treasuries securities was 9.23% from 2009–2013. 15% taxation even in tax-sheltered retirement accounts. RETURN

Despite frequent comparisons with high-yield bonds, Intermediate- 10% preferred securities present a di erent set of risks: term investment- An investment may generate attractive yield income, grade corporates - Prices. Like bonds, preferreds’ prices are in uenced 5% but that doesn’t mean it can take the place of bonds in a by interest rates. However, their prices tend to be Intermediate Long diversi ed portfolio. One of the major appeals of bonds is Treasuries Treasuries more volatile than those of bonds, making preferred that, barring default, they preserve capital. To be a true bond securities more susceptible to short-term losses. 5% 10% 15% 20% 25% 30% 35% alternative, an investment would have to behave like a bond, RISK - Dividends. Companies can suspend or cancel a and that means both providing steady income and o ering preferred dividend payment at will, without facing the Source: Schwab Center for Financial Research with data provided by Morningstar, something in the way of capital preservation. consequences of a default. Inc. The chart compares the risk and return features of various income-oriented - Principal. Unlike bonds, preferred securities never investments, which are represented by the following indexes: Barclays U.S. 1–3 Year Treasury Bond Index, Barclays U.S. Intermediate Treasury Bond Index, Barclays mature, meaning there’s no guaranteed return U.S. Long Treasury Bond Index, Barclays U.S. Intermediate Corporate Bond Index, of principal. Barclays U.S. Corporate High Yield Index, BofA Merrill Lynch Fixed Rate Preferred - Value. Because they make xed payments, preferred Securities Index, Alerian MLP Index and the Dow Jones U.S. Select REIT Index. Risk is represented by the annualized standard deviation of monthly returns, and return is securities usually trade inversely to interest rates. If rates represented by the average annualized total return for the period 1/2009–12/2013. rise, preferred securities generally depreciate. Bond returns assume reinvestment of bond principal and interest and are not adjusted for taxes. Past performance is no guarantee of future results. See page 2 for important information.

©Gina + Matt (1114-5155)

28 CHARLES SCHWAB • W I N T E R 2 014

OI-Wi14-Q4-28 dOI_Wi14_27-29_FT_BondYields.indd 28 10/8/14 9:20 AM oming into 2014, many U.S. bond analysts were expecting a bond bear REITS ANSWERS A REIT is a special corporation that invests in real estate market—in which prices fall and yields rise—amid anticipation of an properties, mortgages or both. Some specialize in speci c improving economy and the winding down of the Federal Reserve’s property types such as shopping malls or o ce buildings, TO COMMON others invest in geographic regions, and some are bond-buying program. Such conditions would have been a welcome diversi ed and invest across property types, regions or both. QUESTIONS Fixed income investors may be attracted to REITs relief for bond investors who have taken to the sidelines while they because they generally distribute a portion of their income What about high-yield bonds? wait for yields to rise. as dividends to shareholders. Such distributions helped High-yield bonds, often derided as “junk,” are push the average annualized total return on the Dow Jones sub-investment-grade corporate bonds that offer Instead, U.S. bonds rallied in the fi rst half of the year, fueled largely by a U.S. Select REIT Index to 16.36% in the 2009–2013 period. higher yields than investment-grade bonds to compensate for their lower credit quality. High-yield Again, it is important to note that such returns come with bonds generally have stronger correlations with lagging economy, dimmer housing prospects and stagnant job creation. added risk. Because REITs o en trade like stocks on major stocks than other types of bonds—meaning that Unrest in the Ukraine and Iraq also helped drive down yields as risk-averse exchanges, their prices can be volatile—of the eight asset when stocks fall, high-yield bonds will often fall, classes compared in the chart at le , REIT prices exhibited as well. That relationship diminishes some of the investors gravitated toward the perceived safety of bonds. the highest risk during the 2009–2013 period. (For more on diversifi cation benefi ts that bonds can offer as part REITs, see “Capitalizing on Global Real Estate” on page 20.) of a portfolio. The low-yield environment has encouraged some investors to consider substituting bonds Another factor to consider is that when yield- with income-oriented investments, such as preferred securities, real estate investment trusts (REITs) MLPS hungry investors pile into high-yield bonds, their MLPs are a niche sector in the income world—most of prices rise—which pushes down yields. This dynamic and master-limited partnerships (MLPs). But where there is additional return or yield, there is usually them are oil and gas partnerships. MLPs trade like stocks on was on display last summer, when the benchmark an exchange and distribute most of their cash  ow to unit Barclays U.S. Corporate High Yield Bond Index hovered around 5%, not too far from its all-time low added risk, as illustrated in the chart at right. holders, who are technically considered limited partners in of 4.95% back in May 2013. In other words, investors the business. Returns on MLPs can be high—the Alerian MLP in such bonds aren’t getting much of a premium over Index had an average annualized total return of 29.55% during more highly rated bonds, even as they’re taking on the 2009–2013 period. But these products also involve risks more default risk. and potential complications that must be weighed carefully. For example, distributions can be diluted if an MLP issues When will Treasuries additional units to raise capital, and energy-linked MLPs yield 5% again? are sensitive to changes in fuel prices. Also, because MLPs That’s the most common question investors ask don’t pay corporate income taxes, unit-holders, as limited Kathy Jones, Vice President, Fixed Income Strategist partners, pay income taxes on their share of the distributions. at the Schwab Center for Financial Research. Her response: Don’t hold your breath. “It could take a  is avoids the problem of double taxation that arises with long while for Treasury yields to rise and, even then, dividends, but it also means additional complexity when 4–4.5% seems a more likely range than the 5–6% ling taxes. And some income from MLPs may be subject to range of the last decade.” taxation even in tax-sheltered retirement accounts. She urges investors considering preferreds, REITs or MLPs to recognize that such products An investment may generate attractive yield income, aren’t true bond alternatives and may add risk to but that doesn’t mean it can take the place of bonds in a their portfolios. diversi ed portfolio. One of the major appeals of bonds is Since interest rates appear poised to rise—albeit that, barring default, they preserve capital. To be a true bond slowly—over the next few years, Kathy cautions alternative, an investment would have to behave like a bond, investors against remaining sidelined in short- and that means both providing steady income and o ering term, low-yielding securities. “If you’re stuck in those investments, you may miss out on generating something in the way of capital preservation. - and compounding income, thereby reducing your cumulative total returns,” she says. Instead, investors may want to consider extending NEXT STEPS their bond portfolio’s duration—or the amount of time For help choosing fi xed income investment s, it takes for the cash fl ows from a bond to cover its call 866-893-6699 to spea k with a S chwab purchase price—as interest rates move up. (To learn Fixed Income Specialist. more about Kathy’s suggestions for bond investors, see “Infl ation Pressure?” on page 12.) See page 2 for important information.

©Gina + Matt (1114-5155)

WINTER 2014 • ON INVESTING 29

OI-Wi14-Q4-29 dOI_Wi14_27-29_FT_BondYields.indd 29 10/2/14 12:15 PM Schwab Fundamental Global Real Estate Index Fund Our new fund offers an Let’s Talk innovative approach to Visit a branch or call global real estate investing. 888-484-5340 to schedule an appointment with a Schwab Financial Consultant. You can also learn more about Schwab’s approach to wealth H management at schwab.com/ allocations. As an asset class, global real OIwealthmanagement. estate has historically delivered solid growth and attractive returns while offering a diversified way of participating in global economic growth—including in potentially A Modern Approach to -- Transparency. We’ll be open faster-growing emerging economies. and honest in all aspects of our That’s why we’re offering an innovative Wealth Management relationship, including what you pay approach to global real estate investing with for our services and the thinking the Schwab Fundamental Global Real Estate Our approach is rooted in transparency and accountability. behind our advice. Index Fund (SFREX)—the first U.S.-based -- Value. We design our products and real estate fund to apply the Fundamental hen it comes to -- Partnering. You’re not just a client services with a goal of driving down Index managing your money, at Schwab. We believe in partnering costs, so investors have more money Affiliates, LLC, to a portfolio of broad-based what is most important with you and getting to know you to invest. global real estate securities. W to you? Perhaps it’s so we can work together on having a personal relationship with a your terms. If you have a financial advisor outside employs a unique approach to indexing by dedicated financial professional who -- Advice. We provide access to of Schwab, ask how their wealth selecting and weighting companies based understands your preferences and commentary and insights from management services compare. If their on three fundamental characteristics: goals. Maybe it’s understanding fees, Schwab experts and advice that answers leave you uncertain about their or knowing where and how your money is understandable, relevant and strategies, fees or other aspects of their 1Schwab’s short-term redemption fee of $49.95 will be charged on redemption of funds purchased through Schwab’s Mutual Fund OneSource is being invested. actionable. services, then maybe it’s time to make funds with no transaction fee) and held for 90 days or less. Schwab reserves the right to exempt certain funds from this fee, including Schwab Funds At Schwab, you don’t have to settle -- Choice. We offer a broad range of a change. When it comes to wealth separate redemption fee, and funds that accommodate short-term trading. For each of these trade orders placed through a broker, a $25 service charge applies. Funds are for one or the other. With our modern investment options from leading management, no questions should go also subject to management fees and expenses. approach to wealth management, you asset managers across the unanswered—because the best outcomes Trades in no-load mutual funds available through the Mutual Fund OneSource service (including Schwab Funds), as well as certain other funds, are available without transaction fees when placed through or our automated phone channels. Schwab reserves the right to change the funds we make available without transaction can expect: industry, not just our own. in life come from being fully engaged. fees and to reinstate fees on any funds. Charles Schwab & Co., Inc. (member SIPC) receives remuneration from fund companies for recordkeeping, shareholder services and other administrative services for shares purchased through its Mutual Fund OneSource service. Schwab also may receive remuneration from transaction fee fund companies for certain administrative services. See page 2 for important information. 2Information as of 6/30/2014. 3The investment advisor and its affiliates have agreed to limit the total annual fund operating expenses (excluding interest, taxes and certain nonroutine expenses) of the Brokerage Products: Not FDIC Insured • No Bank Guarantee • May Lose Value fund to 0.49% for so long as the investment advisor serves as the advisor to the fund. This agreement may be amended or terminated only with the approval of the fund’s Board of Trustees. For the period from 10/21/2014–1/31/2015, the investment advisor has agreed to waive the fund’s net operating expenses to 0.00% (excluding interest, Wealth management refers to products and services available through the operating subsidiaries of The Charles Schwab Corporation, among which there are important taxes and certain nonroutine expenses). differences, including, but not limited to, the type of advice and assistance provided, fees charged, and the rights and obligations of the parties. It is important to understand See page 2 for important information. the differences when determining which products and/or services to select. Investors should carefully consider information contained in the prospectus, including investment objectives, risks, charges and expenses. You The Charles Schwab Corporation provides a full range of brokerage, banking and financial advisory services through its operating subsidiaries. Its broker-dealer subsidiary, Charles Schwab & Co., Inc. (member SIPC), offers investment services and products, including Schwab brokerage accounts. Its banking subsidiary, Charles Schwab Bank can request a prospectus by visiting schwab.com or calling Schwab at 800-435-4000. Please read the prospectus carefully before investing. (member FDIC and an Equal Housing Lender), provides deposit and lending services and products. Past performance is no guarantee of future results. There are eligibility requirements to work with a dedicated Financial Consultant. Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost.

(1114-4780) ©Getty Images (0814-4944)

30 Charles schwab • W i n ter 2 014

OI-Wi14-Q4-30 dOI_Wi14_30-31_SpotLight.indd 30 10/10/14 1:07 PM Schwab Fundamental Global Real Estate Index Fund Our new fund offers an innovative approach to Here are some of the features: global real estate investing. -- Access to global real estate. The fund invests in securities of ere at Schwab, we believe global residential and commercial real estate companies and real estate real estate makes sense as part investment trusts (REITs) in both developed and emerging economies H of many investors’ core portfolio around the globe. allocations. As an asset class, global real -- Opportunity to diversify. The fund provides exposure to more than estate has historically delivered solid 200 securities in 20 countries, including the United States and growth and attractive returns while offering countries in Asia and Europe.2 a diversified way of participating in global -- Competitive expenses. The fund offers a 0.49% expense ratio. As economic growth—including in potentially an introductory offer, Schwab will waive operating expenses until faster-growing emerging economies. January 31, 2015.3 That’s why we’re offering an innovative -- Income potential. By investing in REITs—many of which distribute a approach to global real estate investing with portion of their revenue to shareholders in the form of dividends—the the Schwab Fundamental Global Real Estate fund offers the potential for dividend income. Index Fund (SFREX)—the first U.S.-based real estate fund to apply the Fundamental Index® methodology developed by Research Affiliates, LLC, to a portfolio of broad-based adjusted sales, retained operating cash global real estate securities. flow, and dividends plus buybacks. Next Steps This no-load, no-transaction-fee fund1 If you are looking for an innovative way Learn more about the Schwab employs a unique approach to indexing by to gain exposure to global real estate, then Fundamental Global Real Estate selecting and weighting companies based the Schwab Fundamental Global Real Index Fund at schwab.com/ on three fundamental characteristics: Estate Index Fund could be right for you. OIglobalrealestate.

1Schwab’s short-term redemption fee of $49.95 will be charged on redemption of funds purchased through Schwab’s Mutual Fund OneSource® service (and certain other funds with no transaction fee) and held for 90 days or less. Schwab reserves the right to exempt certain funds from this fee, including Schwab Funds®, which may charge a separate redemption fee, and funds that accommodate short-term trading. For each of these trade orders placed through a broker, a $25 service charge applies. Funds are also subject to management fees and expenses. Trades in no-load mutual funds available through the Mutual Fund OneSource service (including Schwab Funds), as well as certain other funds, are available without transaction fees when placed through schwab.com or our automated phone channels. Schwab reserves the right to change the funds we make available without transaction fees and to reinstate fees on any funds. Charles Schwab & Co., Inc. (member SIPC) receives remuneration from fund companies for recordkeeping, shareholder services and other administrative services for shares purchased through its Mutual Fund OneSource service. Schwab also may receive remuneration from transaction fee fund companies for certain administrative services. 2Information as of 6/30/2014. 3The investment advisor and its affiliates have agreed to limit the total annual fund operating expenses (excluding interest, taxes and certain nonroutine expenses) of the fund to 0.49% for so long as the investment advisor serves as the advisor to the fund. This agreement may be amended or terminated only with the approval of the fund’s Board of Trustees. For the period from 10/21/2014–1/31/2015, the investment advisor has agreed to waive the fund’s net operating expenses to 0.00% (excluding interest, Wealth management refers to products and services available through the operating subsidiaries of The Charles Schwab Corporation, among which there are important taxes and certain nonroutine expenses). differences, including, but not limited to, the type of advice and assistance provided, fees charged, and the rights and obligations of the parties. It is important to understand See page 2 for important information. the differences when determining which products and/or services to select. Investors should carefully consider information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by visiting schwab.com or calling Schwab at 800-435-4000. Please read the prospectus carefully before investing. Past performance is no guarantee of future results. Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost.

©Getty Images (0814-4944)

Winter 2014 • on investing 31

OI-Wi14-Q4-31 dOI_Wi14_30-31_SpotLight.indd 31 10/10/14 1:08 PM Accountabilit y. Yes, it exists.

The Schwab Accountability Guarantee™ for participating investment advisory services*

Introducing the Schwab Accountability Guarantee. If for any reason you’re not happy with one of our participating investment advisory services, we’ll refund your program fee from the previous quarter. While it’s no guarantee against loss, and other fees and expenses may still apply, we stand by our word and will work with you to make things right. If accountability matters to you, talk to us today.

Value Line Funds Available through Charles Schwab:

Income and Growth Fund

Chuck Schwab Chairman and Founder To learn more about portfolio management services, talk to your Financial Consultant Small Cap Opportunities Fund or visit schwab.com/accountability.

Brokerage Products: Not FDIC-Insured • No Bank Guarantee • May Lose Value

* The guarantee applies to the following investment advisory services (“Participating Services”) and associated program fees: (i) Schwab Private Client™ (“SPC”); (ii) Schwab Managed Portfolios™ (“SMP”); and (iii) Managed Account Connection® (“Connection”) for accounts that are managed by investment Trusted By Investors For Over 60 Years advisors affiliated with Charles Schwab & Co., Inc. (“Schwab”)—Windhaven Investment Management, Inc., ThomasPartners, Inc. and Charles Schwab Past performance is no guarantee of future results. Investors should carefully Investment Management, Inc. consider the investment objectives, risks, charges and expense of a fund. This The guarantee does not apply to (i) accounts managed by investment advisors that are not affiliated with Schwab; (ii) accounts managed by Schwab- and other important information about a fund is contained in the fund’s affiliated advisors outside of the SPC, Connection, and SMP programs; or (iii) any other product or service made available by Schwab or its affiliates. SPC, prospectus. For more complete information about these Value Line Funds SMP, and Connection are wrap fee programs sponsored by Schwab. and a copy of a prospectus, contact Schwab at 800-435-4000 or go to If at any time or for any reason you are not completely satisfied with a Participating Service, at your request Schwab will refund the associated program fee www.schwab.com/mutualfunds, or contact your financial advisor. Read the for the previous calendar quarter applicable to the Participating Service. The program fee is a percentage of the eligible assets in your Participating Service prospectus carefully before you invest or send money. account(s). You will receive a credit to your Participating Service account(s) within approximately four weeks of your request. No other fees, commissions, There are risks associated with investing in small and mid-cap charges, expenses, or market losses will be refunded. If Schwab is unable to address your concerns after consulting with you and refunding your program stocks, which tend to be more volatile and less liquid than stocks fee, Schwab will work with you to help meet your financial goals. Schwab reserves the right to change this guarantee in the future after providing notice. For of large companies, including the risk of price fluctuations. additional information regarding associated program fees, please see the disclosure brochure for the Participating Service, available at the time you enroll or upon your request. Charles Schwab & Co., Inc., Member SIPC, receives remuneration The Charles Schwab Corporation provides a full range of securities, brokerage, banking, money management, and financial advisory services through its operating from fund companies and/or their affiliates in the Mutual Fund subsidiaries. Its broker-dealer subsidiary, Charles Schwab & Co., Inc. (member SIPC), offers investment services and products, including Schwab brokerage OneSource® service for recordkeeping, shareholder services and other accounts. Its banking subsidiary, Charles Schwab Bank (member FDIC and an Equal Housing Lender), provides deposit and lending services and products. administrative services. The amount of fees Schwab or its affiliates receive from funds participating in the Mutual Fund OneSource ©2014 The Charles Schwab Corporation. All rights reserved. CS18839-15 (0214-0124) ADP78337-00 (01/14) service is not considered in the Select List selection, nor does any fund pay Schwab to be included in the Select List (XXXX-XXXX).

OI-Wi14-Q4-32 dOI_Wi14_32-33_Spotlight_Ads.indd 32 10/2/14 12:18 PM ADP78337-00_H20900_1b.ai H20900x01A_3u.tif 01.13.14 Epson DS Life is Often Complex.

Your Portfolio Doesn’t Have To Be.

CeLeBRATING oUR MoRNINGSTAR MANAGeR oF The YeAR, DeNNIS LYNCh

We congratulate our colleague Dennis Lynch on being named Morningstar’s 2013 U.S. Domestic Stock Fund Manager of the Year. Dennis and his team exemplify conviction, Value Line Funds Available insight, and long-term through Charles Schwab: thinking — the values we Consider the strive to provide to our clients each day. Value Line Fund 1950 Value Line Asset (VLIFX) Allocation Fund Morgan Stanley Income and Growth Fund 1952 Institutional Fund Growth (VALIX) (VLAAX) Portfolio (MSEGX) is Premier Growth Fund 1956 included on the Q4 2014 (VALSX) Included on the Mutual Fund OneSource Larger Companies Fund 1972 Select List® (VALLX) Q4 2014 Mutual

Small Cap Opportunities Fund 1993 Fund OneSource (VLEOX) Select List® Asset Allocation Fund 1993 (VLAAX)

Past performance is no guarantee of future results. Please consider the investment objectives, risks, charges and expenses of funds carefully before investing. The prospectus contains this and other information about the funds. To obtain a prospectus, go to schwab.com/mutualfunds. Please Trusted By Investors For Over 60 Years read the prospectus carefully before investing. advisors affiliated with Charles Schwab & Co., Inc. (“Schwab”)—Windhaven Investment Management, Inc., ThomasPartners, Inc. and Charles Schwab There is no assurance that the Fund will achieve its investment objective. The Fund Past performance is no guarantee of future results. Investors should carefully is subject to market risk, and you can lose money by investing in this Fund. Investment Management, Inc. consider the investment objectives, risks, charges and expense of a fund. This Morningstar Awards Winner (2013) © Morningstar, Inc. All Rights Reserved. Dennis Lynch The guarantee does not apply to (i) accounts managed by investment advisors that are not affiliated with Schwab; (ii) accounts managed by Schwab- awarded Domestic-Stock Fund Manager of the Year in the U.S. To qualify for the Domestic- and other important information about a fund is contained in the fund’s Stock Fund Manager of the Year award, a manager’s funds must have not only posted affiliated advisors outside of the SPC, Connection, and SMP programs; or (iii) any other product or service made available by Schwab or its affiliates. SPC, prospectus. For more complete information about these Value Line Funds impressive returns for the year, but the manager also must have had a record of delivering SMP, and Connection are wrap fee programs sponsored by Schwab. outstanding long-term risk-adjusted performance and of aligning their interests with and a copy of a prospectus, contact Schwab at 800-435-4000 or go to shareholders. Nominated funds must be Morningstar Medalists — a fund that has garnered a Morningstar Analyst RatingTM of Gold, Silver, or Bronze. Morningstar Analyst Ratings are If at any time or for any reason you are not completely satisfied with a Participating Service, at your request Schwab will refund the associated program fee www.schwab.com/mutualfunds, or contact your financial advisor. Read the based on Morningstar’s current expectations about future events and therefore involve for the previous calendar quarter applicable to the Participating Service. The program fee is a percentage of the eligible assets in your Participating Service prospectus carefully before you invest or send money. unknown risks that may cause Morningstar’s expectations not to occur or to differ account(s). You will receive a credit to your Participating Service account(s) within approximately four weeks of your request. No other fees, commissions, significantly from what was expected. In addition, Morningstar Analyst Ratings are based on There are risks associated with investing in small and mid-cap qualitative evaluation and are thus subjective in nature and should not be used as the sole charges, expenses, or market losses will be refunded. If Schwab is unable to address your concerns after consulting with you and refunding your program basis for an investment decision. The Fund Manager of the Year award winners are chosen stocks, which tend to be more volatile and less liquid than stocks based on Morningstar’s proprietary research and in-depth qualitative evaluation by its fee, Schwab will work with you to help meet your financial goals. Schwab reserves the right to change this guarantee in the future after providing notice. For of large companies, including the risk of price fluctuations. fund analysts. additional information regarding associated program fees, please see the disclosure brochure for the Participating Service, available at the time you enroll or Charles Schwab & Co., Inc., Member SIPC, receives remuneration from fund companies and/or their affiliates in the Mutual Fund OneSource® service for recordkeeping, shareholder services upon your request. Charles Schwab & Co., Inc., Member SIPC, receives remuneration and other administrative services. The amount of fees Schwab or its affiliates receive from The Charles Schwab Corporation provides a full range of securities, brokerage, banking, money management, and financial advisory services through its operating from fund companies and/or their affiliates in the Mutual Fund funds participating in the Mutual Fund OneSource service is not considered in the Select List OneSource® service for recordkeeping, shareholder services and other selection, nor does any fund pay Schwab to be included in the Select List 1114-6490 subsidiaries. Its broker-dealer subsidiary, Charles Schwab & Co., Inc. (member SIPC), offers investment services and products, including Schwab brokerage © 2014 Morgan Stanley & Co. LLC. Member SIPC. CRC 1005878 09/14 accounts. Its banking subsidiary, Charles Schwab Bank (member FDIC and an Equal Housing Lender), provides deposit and lending services and products. administrative services. The amount of fees Schwab or its affiliates receive from funds participating in the Mutual Fund OneSource service is not considered in the Select List selection, nor does any fund pay Schwab to be included in the Select List (1114-6469). JOB INFORMATION SPECIFICATIONS NOTES PROJ. NO.: 7982381/603053970 TRIM SIZE: 3.375" × 9:5" IM MKG McNulty FINISHED SIZE: 3.375” × 9:5” MECH JOB NAME: MorningStar Ad BLEED: NA POST-PROD.: TEMPLATE: CREATIVE STUDIO DESCRIPTION: PICKUP: 1585 Broadway, 23rd Floor PAPER: New York, NY 10036 TBD MODIFIED BY CH AR 08-11-14, CH SKR 09-09-14, CH GR 09-12-14, CLIENT NAME: 180 Varick Street, 3rd Floor McNulty, Catherine CH NS 09-22-14, CH AR 09-23-14, CH KA 09-30-14 New York, NY 10014 PROJECT MGR.: Mitzner, Julie CH MS 09-30-14 OI-Wi14-Q4-33 PRINTING: PDF dOI_Wi14_32-33_Spotlight_Ads.indd 33 COST CENTER: D838 APPROVAL10/21/14 10:56 AM

m2 DUE DATE: 10/01/14 4:30 COLORS: B/W Mutual Fund OneSource Select List® 34 ETF Select List® 43 RESEARCH Argus 47

Mutual Fund OneSource Select List ® Analysis and Commentary on Actively Managed Mutual Funds by Charles Schwab Investment Advisory, Inc.

With thousands of mutual funds available, finding the right funds for your portfolio can seem more time-consuming and difficult than ever. The Mutual Fund OneSource Select List, consisting only of OneSource funds available without a load or transaction fee, is a smart solution that can help you make confident investment decisions.

How Funds Are Selected “Leading Schwab Affiliate Funds” sections of the Select List feature eligible actively managed Schwab Affiliate Funds that generally fall into the top 35 To build the Schwab Mutual Fund OneSource Select List, Charles percent of all CSIA-evaluated funds (including OneSource and non-OneSource Schwab Investment Advisory, Inc. (CSIA) starts by analyzing the funds) in their respective Morningstar categories. If two or more Schwab funds tracked by Morningstar using quantitative and qualitative Affiliate Funds that fit this criteria also have similar investment styles, CSIA may selection criteria described below. Then, based on its analysis, determine that only the most favorably evaluated fund(s) be included in the list. CSIA builds the Mutual Fund OneSource Select List by selecting Because Schwab Affiliate Funds included in the “Leading Schwab Affiliate Funds” section of the OneSource Select List are selected independently from the most favorably evaluated OneSource funds, including Schwab other actively managed funds on the list, they may have a less favorable Funds and Laudus Funds (“Schwab Affiliate Funds”), within each evaluation overall than the funds listed in the “Leading Third-Party Funds” Morningstar category. section of the list. Most of the funds on the List are actively managed OneSource The Index Funds sections of the Select List feature only Schwab Affiliate Funds. funds. In addition, CSIA also includes up to one Schwab Affiliate These sections include up to one market capitalization weighted index fund for Fund that is a market-cap weighted index fund for each of the each of the large-cap, small-cap, international and taxable bond asset classes large-cap, small-cap, international and taxable bond asset classes, and one fundamentally weighted index fund for each of the large cap, small cap, developed large cap international, developed small cap international and and one Schwab Affiliate Fund that is a fundamentally weighted emerging market asset classes. A market capitalization weighted index fund is a index fund for each of the large cap, small cap, developed large cap fund that attempts to match the performance of an established list of securities, international, developed small cap international and emerging where the securities with the highest market capitalization (total market value market asset classes. of outstanding stock) get the most weight. A fundamentally weighted index fund is a fund that attempts to match the performance of an established list of Eligibility Requirements securities, where the securities with the highest fundamental value (measured based on criteria such as sales, cash flow, dividends and stock buybacks) get Each OneSource Select List fund must: the most weight. A Schwab Affiliate fund that is market capitalization weighted Be no-load and open to new investors at Schwab in all 50 states. and a Schwab Affiliate Fund that is fundamentally weighted are included unless Have a minimum three-year performance track record (except funds that are no funds meet Schwab’s quantitative and qualitative evaluation criteria. listed below the “Leading Schwab Affiliate Funds” sections of the list, which The Schwab affiliate index fund that receives the most favorable evaluation by are eligible if they have a minimum 12 months performance track record under CSIA in each asset class is included on the Select List. If two index funds their current management and/or current investment objectives and strategy). receive equal evaluations, CSIA will generally include the fund that has the Have at least $40 million in assets (except for small-cap value, high yield, lower expense ratio. multisector bond, world bond, emerging market equity and bond, diversified Pacific Asia, Pacific Asia ex-Japan, Europe, Japan, Latin America, convertibles, “Leading Third-Party Funds” sections of the OneSource Select List feature eligible retirement income, target date and specialty funds, which require at least $20 actively managed third-party OneSource funds that generally fall within the top million in assets). To meet this requirement, assets in multiple share classes 35 percent of all CSIA-evaluated funds within a given Morningstar category and of the same fund may be aggregated. that receive the most favorable evaluations in their respective categories. Selection Criteria For the OneSource Select List, CSIA generally includes the five most-favorably evaluated funds in each of the large-cap, small-cap, intermediate-term bond, Actively Managed OneSource Funds, including Schwab Affiliate Funds, are municipal national intermediate and foreign large blend asset categories and the evaluated by CSIA based on a quantitative analysis of risk, performance, two most favorably evaluated funds in all other asset categories. If two or more of expenses, active share (when meaningful), assets under management and asset the most favorably evaluated funds within an asset category have similar investment flows. CSIA also may apply additional qualitative factors to its analysis to styles, CSIA may substitute a less-favorably evaluated fund for one or more of enhance its overall evaluation of a fund, including, for example, changes in a those funds to provide a more diverse selection of fund investment strategies. fund’s investment strategy or management structure, portfolio manager tenure, whether a fund’s investment style and portfolio holdings are representative of its investment category, portfolio composition and turnover rates, consistency of a fund’s performance and CSIA’s evaluation of the fund over time, and other risk and diversification considerations.

34 CHARLES SCHWAB • WINTER 2014 Upside and downside capture ratios: a measure of how much a fund Investing in Mutual Funds at Schwab moves in comparison to the broad market when the market goes up or down. Investors should consider carefully information contained in the Upside capture ratio: For the months in which the market return was positive, prospectus, including investment objectives, risks, charges and expenses. what was the ratio of the fund’s returns to the market’s returns? Upside capture You can obtain a prospectus by calling Schwab at 800-435-4000. Please of 110% means that in up markets, the fund went up 10% more than the market read the prospectus carefully before investing. did. For investors who are concerned with growth in rising markets, looking for a Investment value will fluctuate and shares, when redeemed, may be fund with a high upside capture ratio (above 100%) can be useful. worth more or less than original cost. Downside capture ratio: For the months in which the market return was negative, Trades in no-load mutual funds participating in the Mutual Fund OneSource what was the ratio of the fund’s returns to the market’s returns? Downside service (including Schwab Funds), as well as certain other funds, are available capture of 110% means that in down markets, the fund went down 10% more than without loads or transaction fees when placed through schwab.com or one of the market did. For investors who are concerned with minimizing losses, looking our automated phone channels. However, for each of these trades placed for a fund with a low downside capture ratio (below 100%) can be helpful. through a broker, a $25 service charge applies. Additionally, Schwab will charge Generally speaking, it’s good for a fund to have an upside capture ratio at least a short-term redemption fee (STR) if you sell shares of OneSource funds held for as high as its downside capture ratio, and preferably higher. A fund delivering 90 days or less. Schwab reserves the right to exempt some funds from the STR 110% of the market’s positive returns but only 105% of the negative returns fee, including certain Schwab Funds, which may charge a separate redemption means that the fund has delivered more of the market’s upside than downside fee, and funds that accommodate short-term trading. Certain funds may charge (which is desirable). a redemption fee separate, and in addition to, the OneSource STR. All other funds available at Schwab are subject to a transaction fee when bought and sold The “holy grail” for many investors is a fund with a low downside capture ratio and may be subject to fees assessed by the fund itself. Schwab reserves the that has an upside capture ratio of 100% or more. right to change the funds it makes available without transaction fees and reinstate fees on any funds. The absolute level of upside capture and downside capture can be important as well, providing an overall indication of the fund’s risk relative to the market. If ® both ratios are around 120%, it means that the fund has been more volatile than Information on the Mutual Fund OneSource Select List the market (even if upside is higher than downside). If both ratios are around No mention of particular funds or fund families here should be construed as a 80%, it means that the fund has been less volatile than the market. recommendation, or considered an offer to sell, or a solicitation to buy any securities. This information is provided for general information purposes only As with most metrics, these ratios are backward looking (in this case, over the and should not be considered an individualized recommendation or personalized past three years). Just because a fund has delivered a certain percentage of the investment advice. The securities listed may not be suitable for everyone. Each market’s returns in past up markets and down markets doesn’t mean that it is investor needs to review a security transaction for his or her own particular guaranteed to do the same in future up or down markets. situation. Schwab or its employees may sometimes hold positions in the In a three-year period with very few up months or very few down months, the securities listed here. Charles Schwab & Co. Inc. is the underwriter and upside or downside capture ratio can be hard to measure. distributor of Schwab Funds®. These ratios provide no information about the fund’s overall returns and are Except as noted below, all data provided by Morningstar, Inc. ©2014 by simply a measure of performance relative to the market in up periods and in Morningstar, Inc. All rights reserved. The information contained herein is the down periods. proprietary information of Morningstar, Inc., and may not be copied or redistributed for any purpose and may only be used for noncommercial, personal Additional Important Information purposes. The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. Morningstar, Inc., shall not be ® More than 3,500 funds participate in the Mutual Fund OneSource service. responsible for investment decisions, damages, or other losses resulting from Only these funds, including Schwab Affiliate Funds, are eligible for the Select use of the information. Morningstar, Inc., has not granted consent for it to be Lists. Schwab receives remuneration from fund companies, and/or their considered or deemed an “expert” under the Securities Act of 1933. With affiliates, in the Mutual Fund OneSource service, including Schwab Affiliate respect to SchwabFunds, Charles Schwab Investment Management, Inc. Funds, for record keeping, shareholder services and other administrative provides the following data: total net assets, actual and average annual total services. Schwab and its affiliates also receive fees from Schwab Affiliate returns, after-tax returns, annualized quarter-end performance, top ten Funds for investment advisory and fund administration services. The holdings, portfolio breakdowns, expense ratios, and, for Schwab bond funds, aggregate fees Schwab or its affiliates receive from Schwab Affiliate Funds credit ratings, average maturity, and 30-day SEC yield. (see fund prospectuses for more details) are greater than the remuneration Schwab receives from other fund companies participating in Schwab’s Mutual Charles Schwab Investment Advisory (CSIA) is a separately registered investment Fund OneSource service. The amount of fees Schwab or its affiliates receive advisor and an affiliate of Charles Schwab & Co., Inc. Among other functions, from funds participating in the Mutual Fund OneSource service is not CSIA oversees the selection of investments and ongoing monitoring of the Select considered in the Select List selection, nor does any fund pay Schwab to be List and produces market commentary and other investment advice for Schwab included in any Select List. Eligible funds are selected based solely on the clients and financial consultants. (0914-6132) quantitative and qualitative criteria described on pages 34 and 35. Schwab Affiliate Funds include Schwab Funds and Laudus Funds. Schwab Funds and Laudus Funds are advised by Charles Schwab Investment Management, Inc. Schwab Funds and the Laudus MarketMasters Funds are distributed by Charles Schwab & Co., Inc. and Laudus Funds (except Laudus MarketMasters Funds) are distributed by ALPS Distributors, Inc.

WINTER 2014 • ON INVESTING 35 RESEARCH LARGE-CAP U.S. STOCK FUNDS

Perspectives and Third Quarter 2014 Summary In the short-term, escalated global fears could continue to foster volatility for the U.S. equity markets and the recent rally in the dollar may be hardest felt in earnings of larger, multi-national corporations. Moreover, Federal Reserve policy uncertainty can add to investor consternation. However, it is important to keep the longer-term picture in mind, which we believe is positive. The U.S. economy is improving, monetary policy remains quite loose, and in general, a stronger dollar is likely to be both economic and market positive. Large cap U.S. stocks rose modestly, with the Standard & Poor’s 500 Composite Index edging 1.13% higher. Stronger economic data, an uptick in M&A activity and strong corporate earnings buoyed returns in domestic large cap stocks. Large-cap U.S. stocks outperformed small- and mid-cap stocks with returns in flat-to-positive territory. Large-cap Growth Category returned gains of 0.68%, while Large-cap Blend and Large-cap Value were lower with returns of -0.08% and -0.55%, respectively. All perspectives are as of October 14, 2014 For the latest up-to-date perspectives, please visit schwab.com

FOR THE QUARTER ENDED SEPTEMBER 30, 2014

AVERAGE ANNUALIZED TOTAL RETURN UPSIDE DOWNSIDE GROSS NET TOTAL MORNINGSTAR QUOTE 1 3 5 10 SINCE MARKET MARKET EXPENSE EXPENSE ASSETS FUND NAME (FUND INCEPTION DATE) CATEGORY SYMBOL YEAR YEARS YEARS YEARS INCEPTION CAPTURE CAPTURE RATIOa RATIOa ($M) LEADING SCHWAB AFFILIATE FUNDSd Schwab Core Equity Fund (07/01/96) Large Blend SWANX 20.91 22.79 14.30 8.35 8.39 100.76 105.62 0.73 0.73 2,268 Laudus U.S. Large-Cap Growth Fund (10/14/97) Large Growth LGILX 15.80 22.15 16.80 10.93 6.39 100.01 110.50 0.77 0.77 2,173 Schwab Dividend Equity Fund (09/02/03) Large Value SWDSX 17.25 21.56 14.75 8.04 9.14 97.90 109.25 0.89 0.89 2,015 FUNDAMENTAL INDEX FUNDS Schwab Fundamental U.S. Large Co Index Fund (04/02/07) Large Value SFLNX 18.74 23.46 15.42 — 7.56 102.62 104.84 0.41 0.35 4,211 MARKET CAP-WEIGHTED INDEX FUNDS Schwab S&P 500 Index Fund (05/20/97) Large Blend SWPPX 19.63 22.85 15.60 8.07 6.87 99.64 100.28 0.09 0.09 19,872 LEADING 3RD PARTY FUNDS Janus Contrarian T (2/29/00) Large Blend JSVAX 25.17 27.40 13.30 10.16 7.87 105.61 69.21 0.76 0.76 4,163 Parnassus Core Equity Investor (9/1/92) Large Blend PRBLX 18.32 22.74 15.42 10.20 10.85 93.98 78.50 0.87 0.87 9,811 TIAA-CREF Social Choice Eq Retail (3/31/06) Large Blend TICRX 16.62 21.98 14.97 8.22 7.07 98.06 104.58 0.48 0.48 2,479 Oakmark I (8/5/91) Large Blend OAKMX 20.01 25.66 17.10 9.28 13.25 108.61 102.44 0.95 0.95 15,830 Glenmede Large Cap Core Port (2/27/04) Large Blend GTLOX 22.04 25.71 17.79 9.51 9.02 111.67 114.21 0.86 0.86 637 Lord Abbett Growth Leaders A (6/30/11)e Large Growth LGLAX 8.17 20.13 —— 12.67 95.37 86.89 1.24 0.85 1,183 Morgan Stanley Inst Growth A (1/2/96)e Large Growth MSEGX 11.76 20.35 16.87 10.04 8.75 100.77 108.79 0.96 0.96 3,254 TIAA-CREF Large-Cap Growth Retail (3/31/06) Large Growth TIRTX 18.31 23.22 16.06 — 7.94 101.21 102.13 0.85 0.85 2,571 Glenmede Large Cap Growth (2/27/04) Large Growth GTLLX 23.66 25.70 18.63 10.11 9.30 112.92 119.35 0.87 0.87 525 TIAA-CREF Growth & Income Retail (3/31/06) Large Growth TIIRX 17.87 22.51 14.84 9.83 9.06 100.28 107.05 0.79 0.79 4,321 American Century Equity Income Inv (8/1/94) Large Value TWEIX 13.82 16.74 12.22 7.28 10.80 74.27 73.97 0.93 0.93 9,594 Delaware Value® A (9/14/98)e Large Value DDVAX 13.61 21.69 16.29 7.97 7.23 95.08 65.95 1.02 1.02 5,828 Principal Equity Income A (5/31/39)e Large Value PQIAX 10.33 17.47 13.30 7.47 8.73 89.57 98.56 0.93 0.93 5,562 JPMorgan Equity Income A (2/18/92)e Large Value OIEIX 10.23 19.20 15.43 8.16 8.60 91.80 86.79 1.09 1.05 7,698 INTECH U.S. Value T (7/6/09) Large Value JRSTX 16.35 22.82 14.88 — 18.20 102.58 112.62 0.95 0.95 121 PERFORMANCE BENCHMARKS Schwab 1000 Index® (Dividends Reinvested) 25.09 16.46 19.19 8.22 — S&P 500 Index® (Dividends Reinvested) 19.73 22.99 15.70 8.11 — New to the Select List this quarter Asset Class and Performance Benchmark Definitions Large-cap U.S. stock funds invest primarily in stocks that fall in the top 70% of the U.S. market capitalization range as defined by Morningstar, Inc. Growth funds invest in companies that may be experiencing rapid growth in earnings, sales or return on equity. Value funds invest in companies that may have share prices below estimated fair market value, undervalued assets, an opportunity to “turnaround” or lower price-to-earnings or price-to-book ratios. Blend funds invest in a combination of value and growth stocks. The S&P 500® Index includes common stocks of 500 widely held companies. S&P 500 is a registered trademark of The McGraw-Hill Co., Inc. If an expense waiver was in place during the period, the net expense ratio was used to calculate fund performance. A net expense ratio lower than the gross expense ratio may reflect a cap on or contractual waiver of fund expenses. Please read the fund prospectus for details on limits or expiration dates for any such waivers. Performance quoted is past performance and is no guarantee of future results. Current performance may be lower or higher. Visit schwab.com for month’s end performance information. Investment value will fluctuate, and shares, when redeemed, may be worth more or less than original cost.

36 CHARLES SCHWAB • WINTER 2014 MID- AND SMALL-CAP U.S. STOCK FUNDS

Perspectives and Third Quarter 2014 Summary The volatility and coinciding risk aversion amid the heightened global fears that has punished smaller domestic stocks may continue in the short term. However, indicators we look at still point to a renewed uptrend, and the U.S. economy’s relative global strength may be setting more domestically-oriented stocks up for rebound, bolstered by the potential positive impact of the dollar’s rally on earnings of these companies. We recommend sticking to your long-term portfolio asset allocations and not making market cap bets. The Mid- and Small-cap Categories lagged during the quarter, with Mid-caps having relatively better performance to the Small-caps. Mid-cap Growth return -2.29%, followed by mid-cap blend at -3.30% and mid-cap value at -3.42%. Small-cap stocks suffered a steep sell-off, sending the benchmark, Russell 2000® Index down 7.36%. The Small-cap Value Category at -7.14% posted the lowest returns relative to the small- and mid-cap universe, followed by Small-cap Blend with a return of -6.75%, and Small-cap Growth at -5.80%. All perspectives are as of October 14, 2014 For the latest up-to-date perspectives, please visit schwab.com

FOR THE QUARTER ENDED SEPTEMBER 30, 2014

AVERAGE ANNUALIZED TOTAL RETURN UPSIDE DOWNSIDE GROSS NET TOTAL MORNINGSTAR QUOTE 1 3 5 10 SINCE MARKET MARKET EXPENSE EXPENSE ASSETS FUND NAME (FUND INCEPTION DATE) CATEGORY SYMBOL YEAR YEARS YEARS YEARS INCEPTION CAPTURE CAPTURE RATIOa RATIOa ($M) LEADING SCHWAB AFFILIATE FUNDSd Schwab Small-Cap Equity Fund (07/01/03) Small Blend SWSCX 9.08 25.51 16.94 8.91 11.16 123.93 165.78 1.11 1.11 628 FUNDAMENTAL INDEX FUNDS Schwab Fundamental U.S. Small Co Index Fund (04/02/07) Small Blend SFSNX 9.78 23.03 15.14 — 7.88 115.23 161.01 0.48 0.35 1,175 MARKET CAP-WEIGHTED INDEX FUNDS Schwab Small-Cap Index Fund (05/20/97) Small Blend SWSSX 3.95 21.10 14.95 9.03 8.48 106.65 150.33 0.20 0.17 2,435 LEADING 3RD PARTY FUNDS First Eagle Fund of America A (11/19/98)e Mid-Cap Blend FEFAX 11.96 21.58 15.37 9.82 8.92 97.27 80.34 1.42 1.42 2,989 Stewart Capital Mid Cap (12/29/06) Mid-Cap Blend SCMFX 16.66 21.71 16.90 — 9.37 94.66 94.09 1.56 1.21 86 Janus Enterprise T (9/1/92) Mid-Cap Growth JAENX 12.33 20.73 16.07 10.95 10.59 89.14 83.91 0.93 0.93 3,478 Morgan Stanley Inst Mid Cap Growth A (1/31/97)e Mid-Cap Growth MACGX 1.33 13.26 12.60 10.13 9.95 83.40 130.13 0.96 0.96 6,931 TIAA-CREF Mid-Cap Value Retail (10/1/02) Mid-Cap Value TCMVX 15.15 22.31 14.94 10.02 12.73 99.12 104.81 0.76 0.76 4,735 Victory Established Value A (5/5/00)e Mid-Cap Value VETAX 7.57 19.24 13.57 10.19 9.24 97.82 108.22 1.05 1.05 2,038 Nuveen NWQ Small/Mid-Cap Value A (12/15/06)b,e Small Blend NSMAX 1.52 17.43 14.38 — 2.87 98.95 135.85 1.32 1.32 50 Northern Small Cap Core (9/30/99) Small Blend NSGRX 5.68 22.00 16.02 9.30 6.89 106.65 139.21 0.86 0.75 180 Pax World Small Cap Individual Inv (3/27/08) Small Blend PXSCX 7.76 23.22 16.14 — 10.54 96.21 81.64 1.66 1.24 141 Touchstone Small Cap Value Opp A (7/31/03)e Small Blend TSOAX 5.55 22.22 13.02 8.21 10.42 114.04 136.51 2.47 1.51 174 Lazard US Small-Mid Cap Equity Open (1/30/97) Small Blend LZCOX 10.66 22.27 14.40 8.50 8.17 105.04 129.40 1.20 1.20 263 Janus Venture T (4/30/85) Small Growth JAVTX 6.31 22.13 17.55 10.66 12.24 97.56 100.80 0.94 0.94 2,315 Pioneer Oak Ridge Small Cap Growth A (1/3/94)e Small Growth ORIGX -2.64 16.70 13.77 8.82 10.04 82.99 80.35 1.40 1.40 2,087 Eaton Vance Tx-Mgd Small-Cap A (9/25/97)e Small Growth ETMGX -0.42 16.74 12.21 8.85 4.65 94.17 125.47 1.27 1.27 100 ASTON/LMCG Small Cap Growth N (11/3/10) Small Growth ACWDX 9.05 25.16 —— 15.00 111.76 121.28 2.04 1.36 46 Neuberger Berman Small Cap Growth A (5/27/09)e Small Growth NSNAX -3.55 15.97 12.08 8.07 15.12 90.13 118.99 1.83 1.26 79 Perritt Ultra MicroCap (8/31/04) Small Value PREOX 9.71 18.69 15.81 7.48 7.56 78.11 64.49 1.76 1.76 64 Wells Fargo Advantage Spec SmCp Val A (5/7/93)e Small Value ESPAX 4.19 19.68 12.77 7.91 11.23 103.83 127.04 1.41 1.34 655 Delaware Small Cap Value A (6/24/87)e Small Value DEVLX 3.86 18.32 14.46 8.39 11.34 99.42 126.46 1.25 1.25 2,482 Diamond Hill Small Cap A (12/29/00)e Small Value DHSCX 4.37 18.91 12.82 8.07 11.22 100.19 126.06 1.33 1.33 1,343 PERFORMANCE BENCHMARK Russell 2000 Index® (Dividends Reinvested) 3.93 21.26 14.29 8.19 — New to the Select List this quarter Asset Class and Performance Benchmark Definitions Mid-cap U.S. stock funds invest primarily in stocks that fall in the next 20% of the U.S. market capitalization range following large-cap stocks. Small-cap U.S. stock funds generally invest in stocks falling in the bottom 10% of the range. Definitions based on Morningstar, Inc. Growth funds invest in companies that may be experiencing rapid growth in earnings, sales or return on equity. Value funds invest in companies that may have share prices below estimated fair market value, undervalued assets, an opportunity to “turnaround” or lower price-to-earnings or price-to-book ratios. Blend funds invest in a combination of value and growth stocks. The Russell 2000® Index consists of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 98% of the total market value of publicly available domestic equities. Small-cap funds are subject to greater volatility than those in other asset categories. If an expense waiver was in place during the period, the net expense ratio was used to calculate fund performance. A net expense ratio lower than the gross expense ratio may reflect a cap on or contractual waiver of fund expenses. Please read the fund prospectus for details on limits or expiration dates for any such waivers. Performance quoted is past performance and is no guarantee of future results. Current performance may be lower or higher. Visit schwab.com for month’s end performance information. Investment value will fluctuate, and shares, when redeemed, may be worth more or less than original cost.

WINTER 2014 • ON INVESTING 37 RESEARCH INTERNATIONAL STOCK FUNDS

Perspectives and Third Quarter 2014 Summary Our outlook for international funds is mixed. Growth in Europe has weakened and remains at risk of a near-term recession, while in South America, Brazil, is expected to make only a slow recovery from recession. However, economic growth is stabilizing in China and rebounding in Japan. Finally, growth is strengthening in India and expected to remain strong elsewhere in emerging Asia, supporting our current outlook favoring emerging markets within a diversified international portfolio. Developed market non-U.S. equities, represented by the MSCI EAFE® Index, fell -5.88% during the quarter, hampered by a surging dollar and faltering economic growth. The MSCI Japan Index was up 5.8% in local-currency returns on the back of a depreciating yen; down 2.3% in dollar-denominated terms. The Europe Stock category, the largest detractor, declined -7.54% amid weak economic growth, mounting deflationary pressures and a depreciating euro. Emerging markets outperformed developed markets with better relative performance from China and India. The Diversified Emerging Markets Category declined 3.47% during the quarter amid concerns about the potential for tighter monetary policy in the U.S. and geopolitical instability. The China Region Category returned -0.38% on the back of stimulus measures and new reforms regarding state-owned enterprises, partly offsetting worries about slowing economic growth. All perspectives are as of October 14, 2014 For the latest up-to-date perspectives, please visit schwab.com FOR THE QUARTER ENDED SEPTEMBER 30, 2014

AVERAGE ANNUALIZED TOTAL RETURN UPSIDE DOWNSIDE GROSS NET TOTAL MORNINGSTAR QUOTE 1 3 5 10 SINCE MARKET MARKET EXPENSE EXPENSE ASSETS FUND NAME (FUND INCEPTION DATE) CATEGORY SYMBOL YEAR YEARS YEARS YEARS INCEPTION CAPTURE CAPTURE RATIOa RATIOa ($M) LEADING SCHWAB AFFILIATE FUNDSd Schwab® International Core Equity Fund (05/30/08) Foreign Large Blend SICNX 7.29 16.60 8.79 — 2.02 107.09 82.21 1.10 0.86 331 Laudus Mondrian International Equity Investor (06/17/08) Foreign Large Value LIEQX 8.27 12.01 5.79 — 0.24 94.61 89.11 1.19 1.19 76 FUNDAMENTAL INDEX FUNDS Schwab Fundamental Emerg Mkts Lg Co Idx (01/31/08) Diversified Emerging Mkts SFENX -0.26 4.96 2.00 — 0.45 93.70 133.84 0.89 0.50 359 Schwab Fundamental Intl Large Co Idx (04/02/07) Foreign Large Value SFNNX 6.20 14.32 5.06 — 1.42 112.07 105.12 0.52 0.35 941 Schwab Fundamental Intl Small Co Idx (01/31/08) Foreign Small/Mid Blend SFILX 3.62 12.70 8.09 — 5.22 94.49 84.52 0.94 0.50 256 MARKET CAP-WEIGHTED INDEX FUNDS Schwab International Index Fund (05/20/97) Foreign Large Blend SWISX 3.89 14.16 6.49 6.29 4.48 105.59 94.81 0.23 0.19 2,584 LEADING 3RD PARTY FUNDS Matthews China Dividend Investor (11/30/09) China Region MCDFX 7.75 15.37 —— 9.87 86.31 53.04 1.24 1.24 144 Matthews China Small Companies (5/31/11) China Region MCSMX 7.28 13.54 —— -0.41 83.26 59.18 2.04 1.50 22 Baron Emerging Markets Retail (12/31/10) Diversified Emerging Mkts BEXFX 8.17 13.29 —— 5.11 103.10 95.87 1.90 1.50 1,133 Harding Loevner Emerging Markets Advisor (11/9/98) Diversified Emerging Mkts HLEMX 7.01 11.67 6.83 11.23 13.12 103.04 106.07 1.46 1.46 2,394 Matthews Asia Growth Investor (10/31/03) Diversified Pacific/Asia MPACX 5.63 13.80 11.27 10.16 10.17 88.15 66.28 1.12 1.12 807 JPMorgan Intrepid European A (11/2/95)e Europe Stock VEUAX 1.46 17.87 7.48 7.72 9.92 124.73 92.42 1.77 1.51 1,011 FMI International (12/31/10) Foreign Large Blend FMIJX 11.74 18.60 —— 11.55 78.07 18.00 1.15 1.00 473 Manning & Napier International S (8/27/92) Foreign Large Blend EXITX 3.06 10.47 6.16 7.70 8.37 101.19 110.58 1.14 1.11 633 Lazard International Strategic Eq Open (2/3/06) Foreign Large Blend LISOX 6.38 17.86 10.03 — 5.67 110.29 80.11 1.10 1.10 4,765 Aberdeen International Equity A (8/30/00)e Foreign Large Blend GIGAX -1.24 9.23 6.55 8.80 4.13 89.99 84.83 1.33 1.33 844 TIAA-CREF International Eq Retail (3/31/06) Foreign Large Blend TIERX 0.87 15.53 7.59 6.47 2.97 111.35 96.35 0.88 0.88 3,480 Artisan International Investor (12/28/95) Foreign Large Growth ARTIX 5.85 19.22 9.52 8.53 10.11 109.39 70.25 1.20 1.20 17,534 Scout International (9/14/93) Foreign Large Growth UMBWX 0.99 12.11 6.54 7.97 8.53 93.34 86.23 1.02 1.02 5,903 Federated Intl Strategic Val Div A (6/3/08)e Foreign Large Value IVFAX 1.57 9.77 6.48 — 0.49 91.32 84.29 1.29 1.11 868 Brandes International Equity I (12/27/96) Foreign Large Value BIIEX 5.74 13.40 5.29 5.62 8.85 103.71 96.26 1.03 1.00 501 Oberweis International Opportunities (2/1/07) Foreign Small/Mid Growth OBIOX 10.28 28.54 19.73 — 9.59 139.21 68.27 2.20 1.60 406 Lazard International Small Cap Eq Open (2/13/97) Foreign Small/Mid Growth LZSMX 4.88 15.93 10.15 6.06 6.67 95.37 65.67 1.48 1.43 63 ClearBridge International Small Cap A (10/1/10)e Foreign Small/Mid Value LCOAX 2.50 16.23 —— 9.90 94.89 48.60 3.61 1.45 76 Matthews Japan Investor (12/31/98) Japan Stock MJFOX 1.95 12.64 10.72 3.33 5.37 72.50 45.66 1.10 1.10 510 Deutsche Latin America Equity A (5/29/01)e Latin America Stock SLANX -5.62 2.16 -0.99 10.29 9.82 117.43 179.61 1.84 1.72 397 Matthews Asia Small Companies Inv (9/15/08) Pacific/Asia ex-Japan Stk MSMLX 18.75 14.70 13.40 — 17.30 93.36 69.83 1.47 1.47 615 Matthews Asian Growth & Inc Investor (9/12/94) Pacific/Asia ex-Japan Stk MACSX 4.08 11.48 8.74 10.37 10.48 75.99 59.49 1.08 1.08 4,469 Perkins Global Value T (6/29/01) World Stock JGVAX 10.74 14.70 10.60 6.75 7.04 72.77 32.90 1.03 1.03 282 PERFORMANCE BENCHMARKS MSCI EAFE Index (Dividends Reinvested) 4.25 13.65 6.56 6.32 — New to the Select List this quarter Asset Class and Performance Benchmark Definitions Foreign stock funds typically have less than 20% of assets invested in the United States. Funds that do not have a specific growth or value orientation compared to a benchmark are classified as blend funds. World Stock funds invest primarily in equity securities of issuers located throughout the world and generally invest at least 20% of assets in the United States. Regional funds generally hold high concentrations of securities from one specific geographic region. Emerging markets funds generally invest in securities from less developed countries. International investments are subject to risks such as currency fluctuations and political instability. Investing in emerging markets can accentuate these risks. If an expense waiver was in place during the period, the net expense ratio was used to calculate fund performance. A net expense ratio lower than the gross expense ratio may reflect a cap on or contractual waiver of fund expenses. Please read the fund prospectus for details on limits or expiration dates for any such waivers. Performance quoted is past performance and is no guarantee of future results. Current performance may be lower or higher. Visit schwab.com for month’s end performance information. Investment value will fluctuate, and shares, when redeemed, may be worth more or less than original cost. 38 CHARLES SCHWAB • WINTER 2014 SECTOR FUNDS

Perspectives and Third Quarter 2014 Summary With the bifurcation of outlooks for global monetary policy and economic growth, which has underpinned the recent rally in the U.S. dollar, volatility for sectors related to dollar-priced commodities, such as oil and gold, is likely to remain elevated. Meanwhile, we believe the industrial sector should benefit from signs of general improvement in global manufacturing and accommodative monetary policies that should stimulate growth in the developed economies. Moreover, we see the positive trend for the technology sector continuing, bolstered by indications of a further acceleration in capital expenditures by companies. The Specialty categories performed dismally across most sectors. Notably, the Energy (-10.19%) and Precious Metals (-19.11%) sectors experienced the most decline. Falling global oil prices and concerns over production growth held back returns in Refiners, Exploration and Production and Equipment & Services sub-sectors. Weakness in Silver and Platinum prices and Gold Mining Producers added to the woes of the Natural Resources sector already weighed down by a strengthening U.S. dollar. Utilities (-4.80%) and Financials (-1.41%) also posted marginally negative performance. Real Estate (-3.01%) also experienced negative performance, due to investor concerns that the end of quantitative easing in October will lead to rising interest rates. However, Health Care (4.58%) was the strongest performer for the quarter led by Biotechnology and Managed Health Care. All perspectives are as of October 14, 2014 For the latest up-to-date perspectives, please visit schwab.com FOR THE QUARTER ENDED SEPTEMBER 30, 2014 AVERAGE ANNUALIZED TOTAL RETURN UPSIDE DOWNSIDE GROSS NET TOTAL MORNINGSTAR QUOTE 1 3 5 10 SINCE MARKET MARKET EXPENSE EXPENSE ASSETS FUND NAME (FUND INCEPTION DATE) CATEGORY SYMBOL YEAR YEARS YEARS YEARS INCEPTION CAPTURE CAPTURE RATIOa RATIOa ($M) LEADING SCHWAB AFFILIATE FUNDSd FINANCIAL FUNDS (CATEGORY AVERAGE)† 26.50 31.23 20.70 12.27 Schwab Financial Services (7/3/00) Financial SWFFX 14.85 24.29 10.83 3.75 4.97 116.06 74.20 1.03 0.94 80 LEADING 3RD PARTY FUNDS EQUITY ENERGY FUNDS (CATEGORY AVERAGE)† 7.90 13.82 7.09 9.48 BlackRock Natural Resources Inv A (10/21/94)e Equity Energy MDGRX 1.33 10.92 6.04 9.33 9.10 102.09 138.58 1.07 1.07 447 Guinness Atkinson Global Energy (6/30/04) Equity Energy GAGEX 11.77 15.15 7.76 11.97 12.96 122.85 170.64 1.35 1.35 82 EQUITY LIMITED PARTNERSHIP FUNDS (CATEGORY AVERAGE)† 24.41 17.50 —— Tortoise MLP & Pipeline Investor (5/31/11)e Energy Limited Partnership TORTX 22.59 24.31 —— 20.45 104.64 23.79 1.29 1.33 1,936 FINANCIAL FUNDS (CATEGORY AVERAGE)† 11.87 22.86 9.75 2.88 Burnham Financial Services A (6/7/99)e Financial BURKX 5.20 21.01 8.24 4.98 11.78 83.32 -0.33 1.81 1.80 83 Hennessy Large Cap Financial Investor (1/3/97) Financial HLFNX 14.37 25.92 9.22 5.13 8.11 119.78 70.03 1.57 1.57 90 HEALTH FUNDS (CATEGORY AVERAGE)† 26.50 31.23 20.70 12.27 Janus Global Life Sciences T (12/31/98) Health JAGLX 34.31 37.27 23.78 13.61 11.99 121.69 -16.63 0.95 0.95 2,617 Delaware Healthcare A (9/28/07)e Health DLHAX 15.63 27.47 20.82 — 18.68 117.53 30.54 1.38 1.38 405 NATURAL RESOURCES FUNDS (CATEGORY AVERAGE)† 4.95 8.74 6.13 8.34 Putnam Global Natural Resources A (7/24/80)e Natural Resources EBERX -1.11 8.19 4.25 6.12 7.15 101.26 160.35 1.23 1.23 268 ICON Materials S (5/6/97) Natural Resources ICBMX 12.86 20.03 12.12 9.90 5.36 107.71 89.47 1.45 1.45 89 PRECIOUS METALS FUNDS (CATEGORY AVERAGE)† -11.10 -23.28 -10.39 2.08 Tocqueville Gold (6/29/98) Equity Precious Metals TGLDX -5.66 -20.49 -5.47 5.19 11.74 -0.66 236.42 1.35 1.35 1,328 First Eagle Gold A (8/31/93)e Equity Precious Metals SGGDX -12.99 -21.53 -8.44 3.11 5.42 -9.50 209.72 1.25 1.25 1,226 GLOBAL REAL ESTATE FUNDS (CATEGORY AVERAGE)† 5.75 15.02 9.64 6.12 Janus Global Real Estate T (7/6/09) Global Real Estate JERTX 12.02 17.67 11.54 — 16.32 102.66 97.32 1.13 1.13 193 REAL ESTATE FUNDS (CATEGORY AVERAGE)† 12.64 15.77 15.05 7.70 Lazard US Realty Income Open (7/30/08) Real Estate LRIOX 12.38 15.62 15.97 — 12.40 71.65 35.72 1.24 1.24 144 Cohen & Steers Realty Shares (7/2/91)b Real Estate CSRSX 13.38 15.71 14.77 9.05 12.02 84.62 68.57 0.97 0.97 5,577 TECHNOLOGY FUNDS (CATEGORY AVERAGE)† 18.69 20.18 14.33 9.71 Janus Global Technology T (12/31/98) Technology JAGTX 14.62 20.57 15.07 11.09 6.55 109.38 89.07 0.97 0.97 1,054 Matthews Asia Science and Tech Inv (12/27/99) Technology MATFX 22.19 19.96 13.10 11.07 2.62 113.14 103.87 1.18 1.18 178 New to the Select List this quarter † Reflects load-adjusted returns Asset Class and Performance Benchmark Definitions Sector funds concentrate investments in firms that fall into specific industries that produce related products or services. Sector funds, in general, have a low correlation to market indices, such as the S&P 500 Index, so they tend to perform differently than broader market measures. Because of their unique investment objectives, it’s unfair to compare sector funds with broader market indices as they will seldom correlate. When evaluating sector fund performance, it’s more appropriate to compare an individual fund’s returns with the average performance of funds in its category. Due to the concentrated nature of sector funds, they can be more volatile than broadly diversified equity funds. If an expense waiver was in place during the period, the net expense ratio was used to calculate fund performance. A net expense ratio lower than the gross expense ratio may reflect a cap on or contractual waiver of fund expenses. Please read the fund prospectus for details on limits or expiration dates for any such waivers. MLP funds invest in the equity securities of master limited partnerships (“MLPs”). Investments in securities of MLPs involve risks that differ from investments in common stock, including risks related to cash flow, dilution and voting rights. MLP funds also may carry heightened risks including industry concentration, volatility, limited liquidity, issuer-specific risks, valuation and taxation. Many MLP funds are classified for federal tax purposes as a taxable regular corporation (“C corporation”), and are subject to US federal income tax on taxable income at corporate income tax rates, as well as state and local income taxes. These corporate taxes and accruals for deferred tax liabilities could substantially reduce a fund’s net assets (reflected in the fund’s NAV), the amount of income available for distribution and the amount of a fund’s distributions. If an MLP fund is classified for tax purposes as a C corporation, all distributions from a fund’s current or accumulated earnings and profits will be taxable to shareholders as ordinary income. Performance quoted is past performance and is no guarantee of future results. Current performance may be lower or higher. Visit schwab.com for month’s end performance information. Investment value will fluctuate, and shares, when redeemed, may be worth more or less than original cost.

WINTER 2014 • ON INVESTING 39 RESEARCH TAXABLE BOND FUNDS

Perspectives and Third Quarter 2014 Summary In the third quarter, short- and intermediate-term Treasury bond yields moved higher as investors anticipate the first Fed rate hike sometime next year. However, long-term Treasury bond yields moved lower, ending the quarter at 2.49%. We continue to see risks in the lower-rated segments of the market, like sub-investment grade bonds. We think most investors should focus on a core portfolio of high quality investments, and those reaching for yield in the riskier parts of the market should consider moving up in quality. Overall, taxable fixed income funds had relatively flat performance in the third quarter – Barclays U.S. Agg Bond Index returned just 0.17% – but there were still a few standout categories worth noting. The long end of the curve had the strongest tailwind as 30 year U.S. Treasuries fell by 19bps. Bond prices move inversely to yields and Long Government funds took advantage of this appreciation with an average return of 2.59%, followed by Long-Term Bond funds at 0.66%. Riskier spread sectors performed worse this quarter. Emerging Markets Bond funds were the biggest laggard, returning -2.92%. They were followed by High Yield Bond funds (-2.03%) Multisector Bond funds (-1.02%) and Bank Loan funds (-0.67%). Also, modest US GDP growth, low interest rates and weak inflation expectation brought down Inflation-Protected Bond funds by -2.16%. All perspectives are as of October 14, 2014 For the latest up-to-date perspectives, please visit schwab.com FOR THE QUARTER ENDED SEPTEMBER 30, 2014 AVERAGE ANNUALIZED TOTAL RETURN AVG. UPSIDE DOWNSIDE GROSS NET WEIGHTED TOTAL MORNINGSTAR QUOTE 1 3 5 10 SINCE MARKET MARKET EXPENSE EXPENSE MATURITY ASSETS FUND NAME (FUND INCEPTION DATE) CATEGORY SYMBOL YEAR YEARS YEARS YEARS INCEPTION CAPTURE CAPTURE RATIOa RATIOa (YRS) ($M) LEADING SCHWAB AFFILIATE FUNDSe Schwab GNMA Fund (03/03/03) Intermediate Gov’t SWGSX 3.26 1.55 3.41 4.38 4.08 74.63 85.27 0.62 0.57 5.82 290 Schwab Intermediate-Term Bond Fund (10/31/07) Intermediate-Term SWIIX 2.42 1.88 3.93 ­— 4.67 75.19 73.26 0.63 0.46 4.31 368 MARKET CAP-WEIGHTED INDEX FUNDS Schwab Total Bond Market Fund (03/05/93) Intermediate-Term SWLBX 3.77 2.12 3.72 3.13 4.95 95.58 103.76 0.56 0.29 6.82 1,222 LEADING 3RD PARTY FUNDS RidgeWorth Seix Floating RT High Inc I (3/1/06) Bank Loan SAMBX 3.44 6.36 6.08 ­— 4.54 115.86 -21.02 0.61 0.61 5.25 7,149 Lord Abbett Floating Rate A (12/31/07)e Bank Loan LFRAX 0.94 6.15 5.38 ­— 4.21 118.46 -38.82 0.80 0.80 ­— 7,606 Lord Abbett Income A (12/31/81)e Corporate Bond LAGVX 7.10 6.63 7.39 6.37 8.22 191.79 87.00 0.88 0.78 ­— 2,020 BMO TCH Corporate Income Y (12/22/08) Corporate Bond MCIYX 8.47 7.15 7.47 ­— 10.11 197.18 108.51 0.76 0.60 9.91 228 TCW Emerging Markets Income N (3/1/04) Emerging Markets TGINX 6.38 8.75 9.17 9.11 9.16 230.71 113.84 1.10 1.10 6.19 5,328 DoubleLine Emerging Markets Fixed Inc N (4/6/10) Emerging Markets DLENX 11.68 7.66 ­— ­— 7.17 196.69 88.51 1.17 1.17 8.50 654 RidgeWorth Seix High Yield I (12/29/00) High Yield Bond SAMHX 7.39 10.02 9.47 6.53 7.53 228.96 63.66 0.56 0.56 7.14 791 TIAA-CREF High-Yield Retail (3/31/06) High Yield Bond TIYRX 6.78 9.97 9.41 ­— 7.79 237.37 81.78 0.65 0.65 7.00 2,535 American Century ShDur Infl Prot Bd Inv (5/31/05) Inflation-Protected APOIX -0.21 0.68 3.44 ­— 3.72 50.76 72.82 0.57 0.57 3.33 1,225 American Century Infl-Adj Bond Inv (2/10/97) Inflation-Protected ACITX 0.87 0.81 3.96 4.27 5.42 142.72 247.59 0.47 0.47 8.66 3,201 American Century Ginnie Mae Inv (9/23/85) Intermediate Gov’t BGNMX 3.02 1.58 3.45 4.38 6.54 70.78 76.26 0.55 0.55 6.74 1,459 American Century Government Bond Inv (5/16/80) Intermediate Gov’t CPTNX 2.38 0.96 2.94 4.23 6.91 67.06 93.72 0.47 0.47 6.21 1,193 USAA Income (3/4/74)b Intermediate-Term USAIX 5.45 4.38 5.68 5.32 8.32 126.44 75.95 0.58 0.58 7.05 5,288 RidgeWorth Total Return Bond I (12/30/97) Intermediate-Term SAMFX 4.30 2.69 4.47 5.09 5.44 104.22 98.03 0.41 0.41 7.78 1,089 Baird Core Plus Bond Inv (9/29/00) Intermediate-Term BCOSX 5.03 4.06 5.89 5.64 6.27 130.02 95.36 0.55 0.55 7.00 4,820 Metropolitan West Total Return Bond M (3/31/97) Intermediate-Term MWTRX 4.81 5.50 7.05 6.56 7.05 138.99 57.26 0.68 0.68 7.89 37,747 DoubleLine Total Return Bond N (4/6/10) Intermediate-Term DLTNX 4.72 4.68 ­— ­— 8.65 110.29 32.76 0.72 0.72 5.06 37,426 PIMCO Income D (3/30/07) Multisector Bond PONDX 8.61 11.34 12.48 ­— 9.99 213.37 -15.08 0.79 0.79 6.62 38,601 Loomis Sayles Bond Retail (12/31/96) Multisector Bond LSBRX 7.40 9.21 9.19 7.68 8.40 217.44 71.12 0.92 0.92 6.32 24,362 Federated Adjustable Rate Secs Instl (12/3/85) Short Government FEUGX 0.71 0.61 0.96 2.52 4.62 11.66 -1.59 1.00 0.64 ­— 714 Loomis Sayles Ltd Term Govt and Agency A (1/3/89)e Short Government NEFLX -1.60 0.48 1.82 3.09 5.00 46.86 32.24 0.82 0.82 3.23 745 Lord Abbett Short Duration Income A (11/4/93)e Short-Term Bond LALDX 0.42 3.20 3.76 4.27 4.43 78.93 -2.23 0.58 0.58 ­— 37,165 Metropolitan West Low Duration Bond M (3/31/97)b Short-Term Bond MWLDX 1.86 3.78 5.18 3.28 4.25 66.04 -19.66 0.63 0.63 3.32 3,708 RidgeWorth US Gov Sec Ultra-Short Bd I (4/11/02) Ultrashort Bond SIGVX 1.07 0.92 1.23 2.77 2.60 13.86 -9.66 0.38 0.38 3.74 1,775 PIMCO Foreign Bond (USD-Hedged) D (4/8/98) World Bond PFODX 8.65 6.88 7.04 6.22 6.02 150.40 26.99 0.92 0.90 6.82 7,203 Dreyfus/Standish Global Fixed Income A (12/2/09)e World Bond DHGAX 1.99 3.21 4.10 5.59 3.86 119.12 45.19 0.88 0.88 7.67 683 PERFORMANCE BENCHMARKS Barclays U.S. Aggregate Bond Index (Dividends Reinvested) 3.96 2.43 4.12 4.62 ­— New to the Select List this quarter Asset Class and Performance Benchmark Definitions Bond funds invest in corporate, municipal or government debt obligations of different maturities and interest rates. Taxable bond funds generally invest in the debt obligations issued by the U.S. Treasury, other U.S. government agencies and U.S. corporations. They also may invest in high-yield and foreign (non-U.S.) bonds. The Barclays U.S. Aggregate Bond Index tracks the total U.S. bond market, which includes U.S. Treasury, government agency, investment-grade corporate bond and mortgage-backed securities with maturities of at least one year. The index includes reinvestment of interest. If an expense waiver was in place during the period, the net expense ratio was used to calculate fund performance. A net expense ratio lower than the gross expense ratio may reflect a cap on or contractual waiver of fund expenses. Please read the fund prospectus for details on limits or expiration dates for any such waivers. Performance quoted is past performance and is no guarantee of future results. Current performance may be lower or higher. Visit schwab.com for more recent performance information. Investment value will fluctuate, and shares, when redeemed, may be worth more or less than original cost. 40 CHARLES SCHWAB • WINTER 2014 TAX-FREE BOND FUNDS

Perspectives and Third Quarter 2014 Summary We believe that credit conditions in the municipal market continue to improve despite some headline cases. Investors in tax-free funds should continue to earn an attractive after-tax distribution relative to Treasuries and taxable bonds, in our view. For investors who can accept some price volatility but are looking to earn a higher after-tax return, we favor intermediate-term funds. For more risk adverse investors, or those with a need for principal in the near term, we would suggest shorter-term funds. As a whole, municipal bond funds have been standout performers in 2014, and that trend continued through the third quarter as the Barclays Municipal Index returned 1.49%. The municipal market continues to be strong from both a technical and fundamental point of view – supply has been limited, demand is recovering and credit trends are improving as defaults are on the decline. Contrary to the taxable bond market, High Yield Muni funds outperformed all other categories with a quarterly return of 2.43%. Muni California Long funds were close behind, returning an average of 2.20%. Over half the municipal bond categories outperformed the aggregate index, and no categories had a negative return. However, the weakest quarterly performers were Muni National Short and Muni Single State Short, returning just 0.29% and 0.78%, respectively. All perspectives are as of October 14, 2014 For the latest up-to-date perspectives, please visit schwab.com FOR THE QUARTER ENDED SEPTEMBER 30, 2014 AVERAGE ANNUALIZED TOTAL RETURN AVG. UPSIDE DOWNSIDE GROSS NET WEIGHTED TOTAL MORNINGSTAR QUOTE 1 3 5 10 SINCE MARKET MARKET EXPENSE EXPENSE MATURITY ASSETS FUND NAME (FUND INCEPTION DATE) CATEGORY SYMBOL YEAR YEARS YEARS YEARS INCEPTION CAPTURE CAPTURE RATIOa RATIOa (YRS) ($M) LEADING SCHWAB AFFILIATE FUNDSd Schwab Tax-Free Bond Fund (09/11/92) Muni National Interm SWNTX 6.35 3.88 4.44 4.28 5.27 82.86 79.74 0.56 0.49 5.78 632 LEADING 3RD PARTY FUNDS American Century IntermTrm Tx-Fr Bd Inv (3/2/87) Muni National Interm TWTIX 5.17 3.27 3.63 4.01 5.09 80.68 92.54 0.47 0.47 8.88 3,430 USAA Tax Exempt Intermediate-Term (3/19/82)b Muni National Interm USATX 6.63 4.77 4.92 4.49 6.92 91.45 73.65 0.55 0.55 8.96 3,734 Northern Intermediate Tax-Exempt (3/31/94) Muni National Interm NOITX 5.84 3.56 3.58 3.85 4.49 90.25 106.72 0.50 0.46 8.80 2,534 BMO Intermediate Tax-Free Y (2/1/94) Muni National Interm MITFX 6.47 4.32 4.58 4.54 4.66 88.26 79.27 0.62 0.56 4.83 1,524 Baird Intermediate Muni Bd Inv (3/30/01) Muni National Interm BMBSX 3.98 2.34 3.00 3.72 4.34 64.14 81.40 0.55 0.55 5.51 1,129 USAA Tax Exempt Long-Term (3/19/82)b Muni National Long USTEX 9.27 5.92 5.51 4.64 7.59 119.23 105.47 0.54 0.54 17.02 2,363 Northern Tax-Exempt (3/31/94) Muni National Long NOTEX 9.36 4.85 4.61 4.61 5.34 114.72 126.22 0.50 0.46 16.86 791 Federated Shrt-Interm Dur Muni Instl (9/4/81) Muni National Short FSHIX 2.65 1.95 2.41 2.63 4.38 38.07 31.23 0.80 0.47 — 1,161 Wells Fargo Advantage S/T Muni Bd Inv (12/31/91) Muni National Short STSMX 1.78 1.58 2.24 3.01 3.84 21.13 1.97 0.79 0.63 1.84 6,459 American Century High-Yield Muni Inv (3/31/98) High Yield Muni ABHYX 10.06 6.45 6.25 4.10 4.81 131.55 119.01 0.60 0.60 19.11 359 Western Asset Municipal High Income A (11/6/92)e High Yield Muni STXAX 6.52 4.94 5.03 5.16 5.00 129.86 114.54 0.80 0.80 12.52 768 PERFORMANCE BENCHMARKS Barclays Municipal Bond Index (Dividends Reinvested) 7.93 4.56 4.67 4.72 — New to the Select List this quarter Asset Class and Performance Benchmark Definitions Tax-exempt bond funds primarily invest in municipal bonds generally issued by state and local governments to fund general expenditures and public projects. Investment income may be subject to certain state and local income taxes and a portion of income may be subject to the alternative minimum tax (AMT). Capital gains are not exempt from federal income tax. The Barclays Municipal Bond Index is a total-return performance benchmark for the investment-grade tax-exempt bond market. The index includes reinvestment of interest. If an expense waiver was in place during the period, the net expense ratio was used to calculate fund performance. A net expense ratio lower than the gross expense ratio may reflect a cap on or contractual waiver of fund expenses. Please read the fund prospectus for details on limits or expiration dates for any such waivers. Performance quoted is past performance and is no guarantee of future results. Current performance may be lower or higher. Visit schwab.com for month’s end performance information. Investment value will fluctuate, and shares, when redeemed, may be worth more or less than original cost.

NOTES: ALL DATA SHOWN IS AS OF SEPTEMBER 30, 2014 a. Definitions: Gross Expense Ratio—actual expense as stated in the fund’s prospectus. Net Expense Ratio—net amount after any expenses are waived and/or partially absorbed by fund management. b. Fund has an initial minimum investment greater than $2,500. c. Investor Shares™ are available at a lower minimum but with higher operating expenses than Select Shares®. d. Schwab Affiliate Funds include Schwab Funds and Laudus Funds. Schwab Funds and Laudus Funds are advised by Charles Schwab Investment Management, Inc. Schwab Funds and the Laudus MarketMasters Funds are distributed by Charles Schwab & Co., Inc. Laudus Funds, except the Laudus MarketMasters Funds, are distributed by ALPS Distributors, Inc. e. This fund is available without a load through Schwab. The performance figures shown reflect the performance with the load. Please see the Fund Summary on schwab.com for performance without load.

WINTER 2014 • ON INVESTING 41 RESEARCH ADDITIONAL FUND CATEGORIES

FOR THE QUARTER ENDED SEPTEMBER 30, 2014 AVERAGE ANNUALIZED TOTAL RETURN UPSIDE DOWNSIDE GROSS NET TOTAL MORNINGSTAR QUOTE 1 3 5 10 SINCE MARKET MARKET EXPENSE EXPENSE ASSETS FUND NAME (FUND INCEPTION DATE) CATEGORY SYMBOL YEAR YEARS YEARS YEARS INCEPTION CAPTURE CAPTURE RATIOa RATIOa ($M) BALANCED FUNDS—LEADING SCHWAB AFFILIATE FUNDSd Schwab Balanced Fund (11/18/96) Moderate Allocation SWOBX 10.98 13.71 10.11 6.22 6.61 102.21 77.56 0.73 0.63 193 BALANCED FUNDS—LEADING 3RD PARTY FUNDS Oakmark Equity & Income I (11/1/95) Aggressive Allocation OAKBX 10.39 15.02 9.97 8.15 10.92 108.87 76.59 0.77 0.77 19,854 Value Line Asset Allocation (8/24/93) Aggressive Allocation VLAAX 7.67 15.15 12.56 7.71 9.83 109.42 76.24 1.19 1.09 233 American Century One Choice® VryCnsrvInv (9/30/04) Conservative Allocation AONIX 5.57 6.22 5.58 4.90 4.90 52.22 50.67 0.64 0.64 369 JPMorgan Income Builder A (5/31/07)e Conservative Allocation JNBAX 2.52 10.32 8.51 — 5.17 100.74 101.17 1.13 0.75 10,984 Janus Balanced T (9/1/92) Moderate Allocation JABAX 11.77 15.24 9.93 8.57 10.05 109.43 74.73 0.83 0.83 11,908 Greenspring (7/1/83)b Moderate Allocation GRSPX 0.58 10.73 7.57 6.67 9.59 87.46 81.98 0.94 0.94 742 First Eagle Global A (4/28/70)e World Allocation SGENX 2.47 10.17 8.76 9.22 11.92 107.80 122.33 1.13 1.13 48,608 Morgan Stanley Instl Global Strat A (11/1/96)e World Allocation MBAAX 3.29 12.40 9.42 6.71 6.53 104.55 72.73 1.11 1.09 445 TARGET DATE FUNDS—LEADING SCHWAB AFFILIATE FUNDSd Schwab Monthly Income Fund—Max (03/28/08) Retirement Income SWLRX 4.70 3.78 4.47 — 3.82 32.56 32.78 0.66 0.45 56 Schwab Target 2015 Fund (03/12/08) Target Date 2011-2015 SWGRX 7.26 10.75 8.50 — 5.44 86.49 78.74 0.72 0.58 110 Schwab Target 2020 Fund (07/01/05) Target Date 2016-2020 SWCRX 8.64 13.01 9.73 — 6.12 104.20 95.47 0.70 0.65 486 Schwab Target 2025 Fund (03/12/08) Target Date 2021-2025 SWHRX 9.57 14.70 10.68 — 7.36 117.58 108.68 0.79 0.71 332 Schwab Target 2030 Fund (07/01/05) Target Date 2026-2030 SWDRX 10.27 16.02 11.26 — 6.92 127.62 118.17 0.78 0.74 708 Schwab Target 2035 Fund (03/12/08) Target Date 2031-2035 SWIRX 10.86 17.22 11.90 — 7.94 137.10 127.82 0.87 0.78 272 Schwab Target 2040 Fund (07/01/05) Target Date 2036-2040 SWERX 11.39 18.14 12.31 — 7.48 143.87 133.84 0.84 0.80 743 Schwab Target 2045 Fund (01/23/13) Target Date 2041-2045 SWMRX 11.51 ——— 14.47 —— 1.83 0.75 38 Schwab Target 2050 Fund (01/23/13) Target Date 2046-2050 SWNRX 11.84 ——— 14.92 —— 2.13 0.76 31 TARGET DATE FUNDS—LEADING 3RD PARTY FUNDS American Beacon Retire Inc & Apprec Inv (7/1/03) Retirement Income AANPX 4.75 4.93 4.85 4.76 4.61 40.98 38.53 1.11 1.11 102 American Century One Choice 2015 Inv (8/31/04) Target Date 2011-2015 ARFIX 8.18 10.77 8.60 6.39 6.47 85.90 76.56 0.79 0.79 1,219 American Century One Choice 2020 Inv (5/30/08) Target Date 2016-2020 ARBVX 8.69 11.61 9.11 — 5.48 92.38 82.35 0.82 0.82 1,335 American Century One Choice 2025 Inv (8/31/04) Target Date 2021-2025 ARWIX 9.12 12.50 9.64 6.89 7.00 99.70 90.10 0.85 0.85 2,119 American Century One Choice 2030 Inv (5/30/08) Target Date 2026-2030 ARCVX 9.75 13.53 10.21 — 5.50 107.41 96.67 0.87 0.87 1,303 Manning & Napier Target 2030 K (3/28/08) Target Date 2026-2030 MTPKX 10.49 15.31 10.63 — 6.85 121.57 111.04 1.16 1.11 196 American Century One Choice 2035 Inv (8/31/04) Target Date 2031-2035 ARYIX 10.42 14.68 10.88 7.36 7.51 115.76 103.44 0.90 0.90 1,648 American Century One Choice 2040 Inv (5/30/08) Target Date 2036-2040 ARDVX 11.21 15.81 11.51 — 5.97 124.28 111.27 0.93 0.93 964 Manning & Napier Target 2040 K (3/28/08) Target Date 2036-2040 MTTKX 11.66 17.68 11.05 — 7.11 144.54 143.18 1.21 1.12 125 American Century One Choice 2045 Inv (8/31/04) Target Date 2041-2045 AROIX 11.85 16.63 11.90 7.72 7.89 130.92 118.38 0.97 0.97 1,169 American Century One Choice 2050 Inv (5/30/08) Target Date 2046-2050 ARFVX 12.16 17.07 12.10 — 5.81 134.45 122.16 0.98 0.98 533 Manning & Napier Target 2050 K (3/28/08) Target Date 2046-2050 MTYKX 12.04 18.16 11.50 — 7.62 148.27 146.83 1.38 1.12 61 American Century One Choice 2055 Inv (3/31/11) Target Date 2051+ AREVX 12.36 17.38 —— 10.07 136.57 123.55 0.99 0.99 128 ALTERNATIVE FUNDS—LEADING SCHWAB AFFILIATE FUNDSd Schwab Hedged Equity Fund (09/03/02) Long/Short Equity SWHEX 13.49 13.36 8.39 5.75 6.86 62.16 68.86 2.52 1.33 199 ALTERNATIVE FUNDS—LEADING 3RD PARTY FUNDS PIMCO Convertible D (5/2/11) Convertibles PCVDX 18.13 13.62 11.57 6.99 7.61 106.16 91.32 1.11 1.05 214 Gateway A (12/7/77)e Long/Short Equity GATEX 0.28 5.03 4.13 3.45 7.57 33.53 36.01 1.03 0.94 7,930 Glenmede Total Market (12/21/06) Long/Short Equity GTTMX 20.08 23.22 15.61 — 5.41 111.77 144.81 2.29 1.20 56 PIMCO CommoditiesPLUS® Strategy D (5/28/10) Commodities Broad Basket PCLDX -4.52 0.90 —— 4.80 101.98 87.34 1.37 1.24 6,995 Goldman Sachs Commodity Strategy A (3/30/07)e Commodities Broad Basket GSCAX -11.50 -2.72 -0.13 — -5.13 98.61 95.44 1.10 0.97 1,275 Merger Investor (1/31/89) Market Neutral MERFX 3.39 4.06 3.23 3.82 6.69 71.20 -20.35 1.65 1.30 5,397 Arbitrage R (9/18/00) Market Neutral ARBFX 1.01 1.04 1.78 3.45 4.51 9.99 -22.11 2.17 1.44 2,504 PERFORMANCE BENCHMARKS S&P 500 Index® (Dividends Reinvested) 19.73 22.99 15.70 8.11 — Barclays U.S. Aggregate Bond Index (Dividends Reinvested) 3.96 2.43 4.12 4.62 — New to the Select List this quarter Asset Class Definitions Balanced funds invest in a mix of stocks, bonds and cash within one fund and are classified into two categories. Conservative Allocation funds may invest 20% to 50% of assets in equities and 50% to 80% of assets in fixed income and cash. Moderate Allocation funds may invest 50% to 70% of assets in equities, with the balance invested in fixed income and cash. Convertible funds invest primarily in bonds and preferred stocks that can be converted into common stocks. Target maturity or “Lifecycle” funds are managed for investors planning to retire (or to begin withdrawing substantial portions of their investments) in a particular year. These funds provide both asset allocation and rebalancing for investors following an investment strategy that grows more conservative as the target date approaches. Commodity-related products, including futures, carry a high level of risk and are not suitable for all investors. Commodity-related products may be extremely volatile, illiquid and can be significantly affected by underlying commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions, regardless of the length of time shares are held. Investments in commodity-related products may subject the fund to significantly greater volatility than investments in traditional securities and involve substantial risks, including risk of loss of a significant portion of their principal value. If an expense waiver was in place during the period, the net expense ratio was used to calculate fund performance. A net expense ratio lower than the gross expense ratio may reflect a cap on or contractual waiver of fund expenses. Please read the fund prospectus for details on limits or expiration dates for any such waivers. Performance quoted is past performance and is no guarantee of future results. Current performance may be lower or higher. Visit schwab.com for month’s end performance information. Investment value will fluctuate, and shares, when redeemed, may be worth more or less than original cost. Data provided by Morningstar, Inc. ©2014 by Morningstar, Inc. All rights reserved. The information contained herein is the proprietary information of Morningstar, Inc., and may not be copied or redistributed for any purpose and may only be used for noncommercial, personal purposes. The information contained herein is not represented or warranted to be accurate, correct, complete or timely. Morningstar, Inc., shall not be responsible for investment decisions, damages or other losses resulting from use of this information. Morningstar, Inc., has not granted consent for it to be considered or deemed an “expert” under the Securities Act of 1933. 42 CHARLES SCHWAB • WINTER 2014 ETF Select List® A List of Prescreened Low-Cost Exchange-Traded Funds The ETF Select List provides you with a list of prescreened, low-cost ETFs representing one ETF from approximately 67 asset categories. This makes it easier for you to find the right ETFs to fit your investment needs and goals. The List was developed by the experts at Charles Schwab Investment Advisory, Inc.,1 and is updated quarterly.

How ETFs are Selected Selection Criteria To build the Schwab ETF Select List, Schwab analyzes all From among these eligible funds, one is selected for each eligible ETFs using the quantitative and qualitative selection ETF Select List category on the basis of its low cost of criteria described below. This includes both Schwab ETFs™ ownership, assuming a $5,000 purchase into the ETF is made and ETFs from third-party providers. Schwab accepts no online on schwab.com, held for one year, then sold.2 payments for inclusion of any ETF on this List, and all ETFs Estimated total cost of ownership as an annual percentage of are evaluated using the same criteria. invested assets including: Because the ETFs featured typically seek to track their index net operating expenses as closely as possible (not outperform, as actively-managed bid-ask spreads mutual funds seek to do), the List highlights just one ETF per trade commissions (buy and sell) category. Each ETF that makes the List has earned its spot based upon a combination of qualitative and quantitative Commissions can add significantly to the cost of ownership, variables such as cost of ownership, risk, fund structure and particularly smaller positions with shorter holding periods. Schwab does not charge a commission for online trades fit within a given category rather than outperforming its peers. of ETFs in Schwab ETF OneSource,™† giving them a cost Eligibility Requirements advantage in the selection process. Schwab ETFs are the only funds available on Schwab ETF OneSource in certain To be eligible for the ETF Select List, an ETF must meet categories. Investing different amounts, trading more or certain minimum requirements to ensure a basic standard less frequently, trading through brokers with commission of liquidity, viability and structural stability among eligible structures different from Schwab’s, or trading at Schwab ETFs. Eligibility criteria include: through a trading channel like a live representative or assets under management length of track record automated phone, or through a Schwab fee-based service bid-ask spread tracking error that waives commissions, would affect cost of ownership number of competitive market makers estimates and could favor an ETF other than the one selected by Schwab for the List. Other criteria are also considered, such as risk, fund structure and other qualitative factors. For example, a fund may be excluded if its investment style or portfolio holdings are not representative of its asset category; its bid-ask spread reflects a history of occasional large spikes; or its structure makes it more susceptible to adverse tax consequences. To show a broader sampling of ETF providers on the List, no single ETF provider, including Schwab, may represent Want to learn more about the more than one-third of the ETFs on the ETF Select List. If any ETF provider, including Schwab, has more than one- ETFs listed here? Log on to third of the most favorably evaluated funds on the List, one schwab.com/ETFSelectList or more of the second-most favorably evaluated ETFs will be substituted as necessary to limit that ETF provider’s and click on a ticker symbol. representation. ETFs are evaluated and selected quarterly for the List using quarter-end data.

Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can obtain a prospectus by calling 800-435-4000. Please read the prospectus carefully before investing. 1 Charles Schwab Investment Advisory, Inc., a registered investment advisor, is an affiliate of Charles Schwab & Co., Inc. 2 The $5,000 investment size is representative of historical Schwab independent retail client trading activity. The one-year holding period is an estimate based on industry averages and Schwab’s general view regarding the benefits of annual portfolio rebalancing. † Conditions Apply: Trades in ETFs available through Schwab ETF OneSource™ (including Schwab ETFs™) are available without commissions when placed online in a Schwab account. Schwab ETFs are the only funds available on Schwab ETF OneSource in certain categories. Service charges apply for trade orders placed through a broker ($25) or by automated phone ($5). An exchange processing fee applies to sell transactions. Certain types of Schwab ETF OneSource transactions are not eligible for the commission waiver, such as short sells and buys to cover (not including Schwab ETFs). Schwab reserves the right to change the ETFs we make available without commissions. All ETFs are subject to management fees and expenses. Please see pricing guide for additional information. The Select List excludes leveraged ETFs, inverse ETFs, ETNs, actively-managed ETFs, muni bond ETFs with underlying holdings subject to AMT, and unmanaged baskets of securities.

WINTER 2014 • ON INVESTING 43 RESEARCH

EXCHANGE-TRADED FUNDS FOR THE QUARTER ENDED SEPTEMBER 30, 2014

ONLINE ETF SELECT LIST QUOTE GROSS COMMIS- CATEGORY SYMBOL FUND NAME INDEX EXPENSES* SION DESCRIPTION U.S. EQUITY ETFs

Dow Jones U.S. Large Cap † Index covers over 700 largest U.S. firms which comprise Large Core SCHX Schwab U.S. Large-Cap Total Stock Market Index 0.04% $0 about 80% of the U.S. market (by capitalization) Large Growth SCHG Schwab U.S. Large-Cap Growth Dow Jones U.S. Large Cap Growth 0.07% $0† ETF has diversified exposure to large growth names such Total Stock Market Index as Apple, Berkshire Hathaway and Google Large Value SCHV Schwab U.S. Large-Cap Value Dow Jones U.S. Large Cap Value 0.07% $0† ETF has diversified exposure to large value names such Total Stock Market Index as ExxonMobil, GE, and Wells Fargo Mid Core SCHM Schwab U.S. Mid-Cap Dow Jones U.S. Mid Cap 0.07% $0† Over 500 holdings providing U.S. equity exposure to the Total Stock Market Index mid-cap portion of the broader U.S. stock market Mid Growth MDYG SPDR S&P MidCap 400 Growth S&P MidCap 400 Growth Index 0.25% $0† U.S. growth stocks with market caps between $850M and $3.8B selected based on sales growth, earnings growth, & momentum Mid Value MDYV SPDR S&P MidCap 400 Value S&P Mid Cap 400 Value Index 0.25% $0† Holds mid-cap stocks with value characteristics based on: book value to price, earnings to price and sales to price ratios Small Core SCHA Schwab U.S. Small-Cap Dow Jones U.S. Small Cap 0.08% $0† Focuses on over 1700 small-cap companies; index Total Stock Market Index excludes the smallest micro-cap stocks Small Growth SLYG SPDR S&P SmallCap 600 Growth S&P Small Cap 600 Growth Index 0.25% $0† Holds small-cap stocks with growth characteristics and market caps ranging from $250M to $1.2B Small Value SLYV SPDR S&P SmallCap 600 Value S&P Small Cap 600 Value Index 0.25% $0† Holds stocks with value characteristics selected from the S&P 600 Small Cap 600 index Total Stock Market SCHB Schwab U.S. Broad Market ETF Dow Jones U.S. Broad Stock 0.04% $0† Holds over 1900 large to small-cap firms; covers virtually Market Index the entire U.S. stock market (by capitalization) Dividend-focused SCHD Schwab U.S. Dividend Equity ETF Dow Jones U.S. Dividend 100 Index 0.07% $0† Holds U.S. companies that consistently pay dividends and have strong relative fundamental strength based on financial ratios INTERNATIONAL EQUITY ETFs

† Canada included in this index which highlights large and Developed Core SCHF Schwab International Equity ETF FTSE Developed ex U.S. Index 0.08% $0 mid-cap stocks from 20 developed markets Developed stock markets excl. U.S. and Canada. Top Developed Growth EFG iShares MSCI EAFE Growth Index MSCI EAFE Growth Index 0.40% $8.95 index weights are U.K., Japan and Switzerland Developed stock markets excl. U.S. and Canada. Index Developed Value EFV iShares MSCI EAFE Value Index MSCI EAFE Value Index 0.40% $8.95 heavy in Japan, U.K., and financial services Developed Small SCHC Schwab International FTSE Developed Small Cap 0.19% $0† The fund has diversified exposure to international small-cap Small-Cap Equity ex-U.S. Liquid Index companies in over 20 developed international markets Emerging Market Stock SCHE Schwab Emerging Markets Equity ETF FTSE Emerging Index 0.14% $0† Large and mid-cap stocks from over 20 emerging markets. Financials are over 25% of the holdings All World ex-U.S. Stock CWI SPDR MSCI ACWI ex-U.S. MSCI All Country World Index 0.34% $0† Tracks a cap-weighted index of developed and emerging ex USA Index market countries excluding the U.S. Vanguard Total World Stock Holds over 6000 stocks spanning the investable global Global Stock VT Index ETF FTSE Global All Cap Index 0.18% $8.95 stock markets, including emerging markets Europe Stock FEU SPDR STOXX Europe 50 STOXX Europe 50 Index 0.29% $0† Holds 50 of the largest companies in Europe, including Nestle, HSBC, and Royal Dutch Shell Features about 800 stocks, approximately 55% from Pacific Asia Stock VPL Vanguard FTSE Pacific ETF FTSE Developed Asia Pacific Index 0.12% $8.95 Japan; also includes Australia, South Korea and Hong Kong Pacific Asia Includes publicly traded stocks from Australia, ex-Japan Stock EPP iShares MSCI Pacific ex-Japan MSCI Pacific ex-Japan Index 0.50% $8.95 Hong Kong, and Singapore Japan Stock JPP SPDR Russell/Nomura PRIME Japan Russell/Nomura Prime Index 0.50% $0† The index consists of the largest Japanese stocks by market-cap, including Toyota, Mitsubishi and Honda

† Tracks a broad, cap-weighted index of investable Chinese China Stock GXC SPDR S&P China S&P China BMI Index 0.59% $0 shares. The fund’s holdings stretch across all cap sizes New to the ETF Select List this quarter

* “Gross expenses” reflect a fund’s total annual operating expenses as stated in the fund’s prospectus and do not reflect any expense reimbursements or waivers that may exist. Some ETFs appearing on this List may be subject to expense reimbursements and waivers, and less such reimbursements and waivers may have lower total annual operating expenses (i.e., “net expenses”) than indicated herein. Please read the fund prospectus carefully to determine the existence of any expense reimbursements or waivers and details on their limits and termination dates. Charles Schwab & Co., Inc. receives remuneration from third-party ETF companies participating in Schwab ETF OneSource™ for record keeping, shareholder services and other administrative services, including program development and maintenance. Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Unlike mutual funds, shares of ETFs are not individually redeemable directly with the ETF. Shares are bought and sold at market price, which may be higher or lower than the net asset value “(NAV)”. No mention of particular funds or fund families here should be construed as a recommendation or considered an offer to sell or a solicitation of an offer to buy any securities. This information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The securities listed may not be suitable for everyone. Each investor needs to review a securities transaction for his or her own particular situation. Schwab or its employees may sometimes hold positions in the securities listed here. Data contained here is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed. International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, political instability, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks. Small-cap funds are subject to greater volatility than those in other asset categories. High-yield funds invest in lower-rated securities. This subjects these funds to greater credit risk, default risk and liquidity risk. Commodity-related products, including futures, carry a high level of risk and are not suitable for all investors. Commodity-related products may be extremely volatile, illiquid and can be significantly affected by underlying commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions, regardless of the length of time shares are held. Investments in commodity-related products may subject the fund to significantly greater volatility than investments in traditional securities and involve substantial risks, including risk of loss of a significant portion of their principal value. Some specialized exchange-traded funds can be subject to additional market risks. Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Unlike mutual funds, shares of ETFs are not individually redeemable directly with the ETF.

44 CHARLES SCHWAB • WINTER 2014 EXCHANGE-TRADED FUNDS FOR THE QUARTER ENDED SEPTEMBER 30, 2014

ONLINE ETF SELECT LIST QUOTE GROSS COMMIS- CATEGORY SYMBOL FUND NAME INDEX EXPENSES* SION DESCRIPTION BOND ETFs Short Term Barclays U.S. 1–5 Year Government/ Invests in U.S. government and investment grade Broad Market BSV Vanguard Short-Term Bond ETF Credit Float Adjusted Index 0.10% $8.95 corporate bonds with durations from one to five years Vanguard Short-Term Corp Barclays U.S. 1–5 Year Corporate Holds over 1500 short-term, investment grade Short Term Corporate VCSH Bond Index ETF Bond Index 0.12% $8.95 U.S. corporate bonds

SPDR Nuveen Barclays Short Term Barclays Managed Money Municipal † Holds short-term tax exempt bonds (includes: state and local Short Term Muni SHM Municipal Bond Short Term Index 0.20% $0 general obligation, revenue, insured and pre-refunded bonds) Schwab Short-Term Barclays U.S. 1–3 Year Treasury † ETF features about 60 Treasuries which mature in 1–3 years Short Term Treasury SCHO U.S. Treasury ETF Bond Index 0.08% $0

Intermediate † Holds securities that are fixed rate, non-convertible with Broad Market SCHZ Schwab U.S. Aggregate Bond ETF Barclays U.S. Aggregate Bond Index 0.06% $0 at least $250 million of outstanding face value

PIMCO Investment Grade B of A Merrill Lynch † Tracks a market-weighted index of U.S. dollar Intermediate Corporate CORP Corporate Bond U.S. Corporate Index 0.20% $0 denominated investment-grade corporate bonds

SPDR Nuveen Barclays Municipal Barclays Municipal Managed † Tracks the U.S. long term tax-exempt bond market and includes Intermediate Muni TFI Bond Money Index 0.30% $0 general obligation, revenue, pre-refunded and insured issues Schwab Intermediate-Term Barclays U.S. 3–10 Year Treasury † ETF features 69 Treasuries which mature in 3–10 years Intermediate Treasury SCHR U.S. Treasury ETF Bond Index 0.10% $0 Long Term Barclays U.S. Long Government/ Provides diversified exposure to the long-term, Broad Market BLV Vanguard Long-Term Bond Index ETF Credit Float Adjusted Index 0.10% $8.95 investment-grade segment of the U.S. bond market Vanguard Long-Term Corp Bond Barclays U.S. 10+ Year Invests in high-quality (investment-grade) corporate bonds; Long Term Corporate VCLT Index ETF Corporate Bond Index 0.12% $8.95 maintains a dollar-weighted average maturity of 10–25 years Barclays AMT-Free Long Holds tax-exempt municipal bonds issued within the last Long Term Muni MLN Market Vectors Long Municipal Continuous Municipal Index 0.24% $8.95 5 years with nominal maturities of at least 17 years

† Holds U.S. Treasuries with an average maturity of over Long Term Treasury TLO SPDR Barclays Long Term Treasury Barclays Long U.S. Treasury Index 0.13% $0 24 years ® PowerShares Fundamental RAFI Bonds U.S. High Yield 0.50% $0† Tracks an index of high-yield, U.S. bonds that are selected based High Yield PHB High Yield Corp Bond 1–10 Index on the Research Affiliates Fundamental Index® methodology

Barclays U.S. Treasury Inflation Protected † ETF highlights Treasury securities which are designed to TIPS SCHP Schwab U.S. TIPS ETF Securities (TIPS) Index (Series-L) 0.07% $0 adjust for and help protect against inflation

SPDR Barclays International Barclays Global Treasury ex-U.S. † ETF features debt issued by foreign governments: non- International BWX Treasury Bond Capped Index 0.50% $0 dollar denominated, investment grade

PowerShares Emerging Mkts DB Emerging Market USD Liquid † Holds U.S. dollar denominated government bonds issued Emerging Markets PCY Sovereign Debt Balanced Index 0.50% $0 by 22 emerging market countries

B of A Merrill Lynch Core Plus † Dividends on preferreds may appeal to income seekers; Preferred Stock PGX PowerShares Preferred Portfolio Fixed Rate Preferred Securities 0.50% $0 Top 5 holdings are financial firms SECTOR ETFs

Guggenheim S&P Equal Weight S&P Equal Weight Index † Tracks an index of U.S. consumer discretionary stocks Consumer Discretionary RCD Consumer Discretionary Consumer Discretionary Index 0.40% $0 where each holding is rebalanced quarterly to equal weight

Guggenheim S&P Equal S&P Equal Weight † Tracks an index of U.S. consumer staples where each Consumer Staples RHS Weight Consumer Staples Consumer Staples Index 0.40% $0 holding is rebalanced quarterly to equal weight Energy RYE Guggenheim S&P Equal S&P 500 Equal Weight Index Energy 0.40% $0† Tracks an index of U.S. energy stocks where each Weight Energy holding is rebalanced quarterly to equal weight First Trust NASDAQ Clean Edge NASDAQ® Clean Edge® Green Tracks stocks that develop and manufacture emerging clean- Clean Energy QCLN Green Energy Energy Index 0.98% $8.95 energy technologies, including biofuels and advanced batteries

Guggenheim S&P Equal S&P 500 Equal Weight Index † Tracks an index of U.S. financial stocks where each Financial RYF Weight Financial Financials 0.40% $0 holding is rebalanced quarterly to equal weight Health Care RYH Guggenheim S&P Equal S&P 500 Equal Weight Index 0.40% $0† Tracks an index of U.S. healthcare stocks where each Weight Health Care Health Care holding is rebalanced quarterly to equal weight

Guggenheim S&P Equal † Tracks an index of U.S. industrial stocks where each Industrials RGI Weight Industrials S&P Equal Weight Industrials Index 0.40% $0 holding is rebalanced quarterly to equal weight MSCI U.S. Investable Market Includes companies in a wide range of commodity-related manu- Materials VAW Vanguard Materials Materials 25/50 Index 0.14% $8.95 facturing industries (e.g. chemicals, paper, metals and minerals) Technology RYT Guggenheim S&P Equal S&P 500 Equal Weight Index 0.40% $0† Tracks an index of U.S. technology stocks where each Weight Technology Information Technology holding is rebalanced quarterly to equal weight Fidelity MSCI MSCI USA IMI Telecommunication Holds telecom stocks including AT&T, Verizon and Telecommunications FCOM Telecommunication Services Services 25/50 Index 0.12% $8.95 CenturyLink weighted by market cap Utilities RYU Guggenheim S&P Equal S&P 500 Equal Weight Index Tele- 0.40% $0† Tracks and index of US utilities stocks where each holding Weight Utilities communication Services & Utilities is rebalanced quarterly to equal weight New to the ETF Select List this quarter † Conditions Apply: Trades in ETFs available through Schwab ETF OneSource™ (including Schwab ETFs™) are available without commissions when placed online in a Schwab account. Schwab ETFs are the only funds available on Schwab ETF OneSource in certain categories. Service charges apply for trade orders placed through a broker ($25) or by automated phone ($5). An exchange processing fee applies to sell transactions. Certain types of Schwab ETF OneSource transactions are not eligible for the commission waiver, such as short sells and buys to cover (not including Schwab ETFs). Schwab reserves the right to change the ETFs we make available without commissions. All ETFs are subject to management fees and expenses. Please see pricing guide for additional information. Many fixed-income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks, including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. The lower-rated securities in which some bond funds invest are subject to greater credit risk, default risk and liquidity risk. Government bond fund shares are not guaranteed. Their price and investment return will fluctuate with market conditions and interest rates. Shares, when redeemed, may be worth more or less than their original cost. Risks of REITs are similar to those associated with direct ownership of real estate, such as changes in real-estate values and property taxes, interest rates, cash flow of underlying real-estate assets, supply and demand, and the management skill and creditworthiness of the issuer. Since a sector fund is typically not diversified and focuses its investments on companies involved in a specific sector, the fund may involve a greater degree of risk than an investment in other mutual funds with greater diversification. Charles Schwab Investment Management, Inc., (“CSIM”) the investment advisor for the Schwab ETFs and an affiliate of Schwab, receives fees from the Schwab ETFs for investment advisory and fund administration services. The amount of fees CSIM receives from the Schwab ETFs is not considered in ETF Select List selection, nor do the Schwab ETFs or any third-party ETF, or any of their affiliates, pay Schwab to be included in the ETF Select List. Schwab ETFs are distributed by SEI Investments Distribution Co. (SIDCO). SIDCO is not affiliated with The Charles Schwab Corporation or any of its affiliates. ©2014 Charles Schwab & Co., Inc. (Member SIPC) All rights reserved. (1014-7132) WINTER 2014 • ON INVESTING 45 RESEARCH

EXCHANGE-TRADED FUNDS FOR THE QUARTER ENDED SEPTEMBER 30, 2014

ONLINE ETF SELECT LIST QUOTE GROSS COMMIS- CATEGORY SYMBOL FUND NAME INDEX EXPENSES* SION DESCRIPTION REAL ASSETS

SummerHaven Dynamic † 14 futures contracts on precious metals, industrial metals, Commodities Broad USCI United States Commodity Index Commodity Index Total Return 1.14% $0 energy and agricultural products. Investors will receive K-1s DBIQ Diversified Agriculture Index Uses futures contracts to access a cornucopia of coffee, sugar, Agriculture DBA PowerShares DB Agriculture Excess Return 0.85% $8.95 livestock, grain, cocoa. Investors will get K-1s at tax time

† Each share backed by gold bullion held in a Swiss vault; Gold SGOL ETFS Physical Swiss Gold Shares Gold Spot 0.39% $0 provides direct exposure to gold price movements

Silver, Gold, Platinum and † ETF is structured as a grantor trust; holds gold, silver, Broad Precious Metals GLTR ETFS Physical PM Basket Shares Palladium Spot 0.60% $0 platinum and palladium DBIQ Optimum Yield Industrial Tracks a proprietary index including aluminum, copper and Industrial Metals DBB PowerShares DB Base Metals Metals Index Excess Return 0.75% $8.95 zinc using futures contracts. Investors will get K-1s at tax time

† Holds futures contracts expiring in 12 consecutive months Oil USL United States 12 Month Oil 12 Month Light Sweet Crude Oil 0.99% $0 for light, sweet crude. Investors will get K-1s at tax time Broad Energy DBIQ Optimum Yield Energy Index Holds futures contracts on light sweet crude, heating oil, Commodities DBE PowerShares DB Energy Excess Return 0.75% $8.95 Brent oil, gasoline and natural gas. Investors will get K-1s

† Invests in REITs (real estate investment trusts) that own and Real Estate SCHH Schwab U.S. REIT ETF Dow Jones U.S. Select REIT Index 0.07% $0 commonly operate commercial and residential properties SPECIALTY ETFs

† Holdings may include U.S. stocks, ADRs, REITs, MLPs, closed- Multi-Asset Income CVY Guggenheim Multi-Asset Income Zacks Multi-Asset Income Index 0.89% $0 end funds and/or Canadian royalty trusts; Top sector is financials ALTERNATIVE WEIGHTED ETFs EQUAL WEIGHTED ETFs

U.S. Large † Compared to market cap weighted indexes, this ETF has lower Weighted Equal RSP Guggenheim S&P 500 Equal Weight S&P 500 Equal Weight Index 0.40% $0 exposure to the largest companies; Index is rebalanced quarterly FUNDAMENTAL WEIGHTED ETFs

U.S. Large Schwab Fundamental Russell Fundamental † Diversified exposure to large U.S. stocks; Holdings are weighted Weighted Fundamental FNDX U.S. Large Company U.S. Large Company Index 0.32% $0 based on fundamental measures of company performance

U.S. Small Schwab Fundamental Russell Fundamental U.S. Small † Stocks are selected based on company fundamentals: retained Weighted Fundamental FNDA U.S. Small Company Company Index 0.32% $0 operating cash flow, adjusted sales and dividends plus buybacks International FNDF Schwab Fundamental Russell Fundamental Developed 0.32% $0† Exposure to large, int’l companies selected and weighted Weighted Fundamental International Large Company ex-U.S. Large Company Index based on fundamental measures of company performance LOW VOLATILITY WEIGHTED ETFs ® U.S. Large Weighted ® † Holds 100 stocks from the S&P 500 Index with the Low Volatility SPLV PowerShares S&P 500 Low Volatility S&P 500 Low Volatility Index 0.25% $0 lowest realized volatility over the past 12 months U.S. Small Weighted PowerShares S&P Small Cap S&P SmallCap 600 Tracks a volatility weighted index of the 120 least volatile Low Volatility XSLV Low Volatility Low Volatility Index 0.34% $8.95 securities from the S&P SmallCap 600 Index International Weighted IDLV PowerShares S&P International S&P BMI International Developed 0.35% $0† Holds the 200 least volatile large and mid cap stocks Low Volatility Developed Low Volatility Low Volatility Index excluding the U.S. and South Korea over the past 12 months New to the ETF Select List this quarter

TRADITIONAL INDEXES These ETFs track indexes that are mostly weighted by market capitalization; that is, they give the most weight to companies whose outstanding stock is worth the most money. The advantages of ETFs that track market capitalization or traditional weighted indexes are that they require very little rebalancing (which keeps costs low) and that they reflect the way the market itself is weighted. In some cases a different weighting scheme may be traditional, such as commodity indexes that are weighted by the liquidity of various commodities.

ALTERNATIVE WEIGHTED ETFS There are three Alternative Weighted ETF categories on the ETF Select List. Each category has a specific approach to building an index so you can consider which ETFs are best for your situation. • EQUAL-WEIGHTED INDEXES: Most indexes are weighted by market capitalization, where companies with the highest stock market value get the most weight. Equal-weighted indexes give an equal amount of weight to each stock in the index. If an ETF tracks an equal-weighted index with 100 stocks, it would generally put about 1% of the fund’s assets into each of the stocks. • FUNDAMENTAL-WEIGHTED INDEXES: Rather than relying on stock market values for weights, a fundamental index uses criteria such as companies’ profits, dividends, book value, cash flow or number of employees to assign weight to the stocks in the index. The theory is to put more weight into stocks that have a larger economic footprint rather than just a large market value. • LOW VOLATILITY-WEIGHTED INDEXES: In these funds, the lower the volatility of a stock, the more weight it receives in the index. The goal is to arrive at a group of stocks whose overall volatility is lower than the market as a whole, which means that the index may gain less than the market during rallies but lose less than the market during declines.

46 CHARLES SCHWAB • WINTER 2014 RESEARCH: ARGUS RESEARCH CO.

ARGUS Log in to schwab.com/OIresearch anytime to access: RESEARCH - Timely market updates: Argus publishes a variety of intraday, daily and weekly updates that examine current market conditions, ratings changes, earnings estimates and more. s a service to clients, we provide - Monthly digest: The Argus Update offers commentary on recent market access to a variety of third-party and economic conditions paired with a model portfolio of 30 stocks Argus A research, such as that from favors to suit the current environment. Argus Research Co., an independent - Argus Model Portfolios: These three model portfolios (shown below) focus investment-research rm that o ers on equity income, growth and income, and mid-cap growth. Changes to forecasts and ratings on the U.S. economy, the portfolios are executed monthly. interest rates and blue-chip companies.

BASIC EQUITY INCOME GROWTH & INCOME MID-CAP GROWTH MATERIALS

12% 3% 6% 6% 5% 4% 11% CONSUMER 10% 14% DISCRETIONARY 6% 17% 26% 10% CONSUMER STAPLES 13% 8% 13%

10% 12% ENERGY 10% 11% 11% 13% 6% 13% 10% FINANCIAL 11% 14% 14%

HEALTHCARE International Paper Co. - IP - Basic Materials Dow Chemical Co. - DOW - Basic Materials Ashland Inc. - ASH - Basic Materials Ford Motor Co. - F - Consumer Discretionary Weyerhaeuser Co. - WY - Basic Materials Bed Bath & Beyond Inc. - BBBY - Consumer Discretionary Gannett Co Inc. - GCI - Consumer Discretionary Las Vegas Sands Corp. - LVS - Consumer Discretionary Dick’s Sporting Goods Inc. - DKS - Consumer Discretionary Lowe’s Companies Inc. - LOW - Consumer Discretionary Time Warner Inc. - TWX - Consumer Discretionary Lions Gate Entertainment Corp. - LGF - Consumer Discretionary Archer Daniels Midland Co. - ADM - Consumer Staples Williams-Sonoma Inc. - WSM - Consumer Discretionary Pep Boys-Manny Moe & Jack - PBY - Consumer Discretionary INDUSTRIALS Clorox Co. - CLX - Consumer Staples Costco Wholesale Corp. - COST - Consumer Staples Scripps Networks Interactive Inc. - SNI - Consumer Discretionary PepsiCo Inc. - PEP - Consumer Staples Hershey Co. - HSY - Consumer Staples Coca-Cola Enterprises Inc. - CCE - Consumer Staples ConocoPhillips Co. - COP - Energy Procter & Gamble Co. - PG - Consumer Staples Estee Lauder Companies Inc. - EL - Consumer Staples Marathon Oil Corp. - MRO - Energy Whole Foods Market Inc. - WFM - Consumer Staples Keurig Green Mountain Inc. - GMCR - Consumer Staples TECHNOLOGY Noble Corporation PLC - NE - Energy HollyFrontier Corp. - HFC - Energy Apache Corp. - APA - Energy Paragon Offshore PLC - PGN - Energy Occidental Petroleum Corp. - OXY - Energy Devon Energy Corp. - DVN - Energy Boston Properties Inc. - BXP - Financial Schlumberger Ltd. - SLB - Energy Noble Corporation PLC - NE - Energy TELE- Chubb Corp. - CB - Financial American Express Co. - AXP - Financial Paragon Offshore PLC - PGN - Energy COMMUNICATIONS HCP Inc. - HCP - Financial Bank of New York Mellon Corp. - BK - Financial American Campus Communities Inc. - ACC - Financial JPMorgan Chase & Co. - JPM - Financial Federated Investors Inc. - FII - Financial CME Group Inc. - CME - Financial Eli Lilly & Co. - LLY - Healthcare Prudential Financial Inc. - PRU - Financial AmerisourceBergen Corp. - ABC - Healthcare GlaxoSmithKline PLC - GSK - Healthcare Amgen Inc. - AMGN - Healthcare Cerner Corp. - CERN - Healthcare UTILITY Johnson & Johnson - JNJ - Healthcare Pfi zer Inc. - PFE - Healthcare Incyte Corp. - INCY - Healthcare Caterpillar Inc. - CAT - Industrials Stryker Corp. - SYK - Healthcare Perrigo Company PLC - PRGO - Healthcare General Electric Co. - GE - Industrials Cummins Inc. - CMI - Industrials Aecom Technology Corp. - ACM - Industrials Harsco Corp. - HSC - Industrials General Electric Co. - GE - Industrials Eaton Corp Pub Ltd Co. - ETN - Industrials Cisco Systems Inc. - CSCO - Technology Masco Corp. - MAS - Industrials JetBlue Airways Corp. - JBLU - Industrials Seagate Technology PLC - STX - Technology United Parcel Service Inc. - UPS - Industrials Parker-Hannifi n Corp. - PH - Industrials Symantec Corp. - SYMC - Technology Apple Inc. - AAPL - Technology Stanley Black & Decker Inc. - SWK - Industrials Xilinx Inc. - XLNX - Technology Broadcom Corp. - BRCM - Technology Activision Blizzard Inc. - ATVI - Technology AT&T Inc. - T - Telecommunications Corning Inc. - GLW - Technology Altera Corp. - ALTR - Technology Verizon Communications Inc. - VZ - Telecommunications EMC Corp. - EMC - Technology Blackhawk Network Holdings Inc. - HAWK - Technology Great Plains Energy Inc. - GXP - Utility Consolidated Edison Inc. - ED - Utility Broadcom Corp. - BRCM - Technology PG&E Corp. - PCG - Utility Oneok Inc (New) - OKE - Utility CA Inc. - CA - Technology Spectra Energy Corp. - SE - Utility CIENA Corp. - CIEN - Technology UIL Holdings Corp. - UIL - Utility eBay Inc. - EBAY - Technology IHS Inc. - IHS - Technology Vishay Intertechnology Inc. - VSH - Technology Aqua America Inc. - WTR - Utility MDU Resources Group Inc. - MDU - Utility

See page 2 for important information. The research is prepared by Argus, independent of Charles Schwab & Co., Inc., and its affi liates (collectively “Schwab”). None of the information constitutes a recommendation by Schwab or a solicitation of an offer to buy or sell any securities. The information is not intended to provide tax, legal or investment advice. Schwab does not guarantee the suitability or potential value of any particular investment or information source. Schwab does not guarantee the accuracy, timeliness, completeness or correct sequencing of the information, or warrant any results from use of the information. Percentages in portfolios may total more or less than 100% due to rounding. Data as of 8/13/2014. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Schwab and/or affi liates may publish or otherwise express other viewpoints or opinions that also may be different from certain of the viewpoints or opinions expressed in these materials. The information here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities mentioned may not be suitable for everyone. Each investor should review a security transaction for his or her own particular situation. (1114-4851)

WINTER 2014 • ON INVESTING 47

OI-Wi14-Q4-47 dOI_Wi14_47_Argus.indd 47 10/2/14 12:19 PM dOI_Wi14_48_OYS.indd 48 On 48 (1114-4963) There are eligibilityrequirements toworkwithadedicatedFinancialConsultant. subsidiary, CharlesSchwabBank(member FDICandanEqualHousingLender), provides depositandlendingservicesproducts. dealer subsidiary, CharlesSchwab&Co., Inc.(memberSIPC),offersinvestmentservicesandproducts, includingSchwabbrokerage accounts.Itsbanking The CharlesSchwabCorporationprovides afullrange ofbrokerage, bankingandfinancialadvisoryservicesthrough itsoperatingsubsidiaries.Itsbroker- important tounderstandthedifferences whendeterminingwhichproducts and/orservicestoselect. important differences, including,butnotlimitedto, thetypeofadviceandassistanceprovided, feescharged, andtherightsobligationsofparties.Itis Wealth management refers toproducts andservicesavailablethrough theoperatingsubsidiariesofTheCharlesSchwabCorporation,amongwhichthere are information. See page2forimportant your side your Charles s built on trust and built ontrustand . We We engagement. honor our clients’ honor ourclients’ encourage tough encourage tough accountability. “ questions and questions and We believein relationships relationships c demands for demands for hwab Brokerage Products:NotFDICInsured•NoBankGuaranteeMayLoseValue • W • OI-Wi14-Q4-48 i n t e r 2 014 014 2 r e t n i ” T interaction. management requires wealth Successful E R Financial Consultants work who offerings service. and ways to deliver better investment we are constantly looking for demands for accountability. And questions and honor our clients’ engagement. We encourage tough relationships built on and trust We them. serve who in believe financialthe professionals investors from respect deserve your money? people helpthe who you manage anythingyou expect less from andfriends colleagues. Should ofthem your family members, strong relationship. You expect defining characteristics of a That commitmentwith starts At Schwab, we believe ngage eady to to eady these arethese three the Transparency. For me, Respect. rust. Founder &Chairman Charles wealth management. and more engaging approach to throughexperience amodern for creating abetter investing We’ll share with you our passion oftype guidance, cometo us. talk life. If you’re interested inthis ownershiptake of your financial trustworthy guidance to help you about providing transparent, management, and it’s all not just from Schwab. managers across industry— the investments from leading asset well as access to array awide of insights and commentary, as our robust offering of investment are compensated. It extends to how our financial professionals what you pay and for our services to your questions—including straightforward, honest answers your involvement and provide hard on your encourage behalf, We wealth this call R . Schwab

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Now with more than 175 commission-free ETFs.1 With the newly expanded Schwab ETF OneSource, you have access to more commission-free ETFs, across more categories, from twice as many providers. Plus, with no early redemption fees, you’ll have more money to invest. T:10.5” T:10.5"

Visit Schwab.com/ETFOneSource to start trading. Or call 1-877-566-2117 for more information.

1. Conditions Apply: Trades in ETFs available through Schwab ETF OneSource™ (including Schwab ETFs™) are available without commissions when placed online in a Schwab account. Service charges apply for trade orders placed through a broker ($25) or by automated phone ($5). An exchange processing fee applies to sell transactions. Certain types of Schwab ETF OneSource transactions are not eligible for the commission waiver, such as short sells and buys to cover (not including Schwab ETFs). Schwab reserves the right to change the ETFs we make available without commissions. All ETFs are subject to management fees and expenses. Please see the Charles Schwab Pricing Guide for additional information. Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges, and expenses. You can request a prospectus by calling Schwab at 1-800-435-4000. Please read the prospectus carefully before investing. Investment returns will fl uctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Unlike mutual funds, shares of ETFs are not individually redeemable directly with the ETF. Shares are bought and sold at market price, which may be higher or lower than the net asset value (NAV). Charles Schwab & Co., Inc., receives remuneration from third-party ETF companies participating in Schwab ETF OneSource™ for recordkeeping, shareholder services, and other administrative services, including program development and maintenance. Schwab ETFs are distributed by SEI Investments Distribution Co. (SIDCO). SIDCO is not affi liated with Charles Schwab & Co., Inc. Learn more at schwab.com/SchwabETFs. Third-party Schwab ETF OneSource shares purchased may not be immediately marginable at Schwab. Charles Schwab Investment Management, Inc., is the investment advisor for Schwab ETFs and an affi liate of the Charles Schwab Corporation. “SPDR” is a registered trademark of Standard & Poor’s Financial Services LLC (“S&P”) and has been licensed for use by State Street Corporation. No fi nancial product offered by State Street Corporation or its affi liates is sponsored, endorsed, sold, or promoted by S&P or its affi liates, and S&P and its affi liates make no representation, warranty, or condition regarding the advisability of buying, selling, or holding units/shares in such products. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Invesco PowerShares and Invesco Distributors, Inc., are indirect, wholly owned subsidiaries of Invesco Ltd. USCF® and the United States Commodity Funds® are registered trademarks of United States Commodity Funds LLC. All rights reserved. “ETF Securities” is a registered trademark of ETF Securities Limited. The “ETF Securities” logo is a registered trademark of ETF Securities Limited.

Brokerage Products: Not FDIC-Insured • No Bank Guarantee • May Lose Value

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