Portfolio manager Cale Smith on investing, Spoke Funds®, and Islamorada in the Florida Keys.

Leaving aside the issue of whether cap and trade will accomplish its goals, it’s hard to refute that Wall Street would make a killing on it. At the core of the cap and trade system, you see, are carbon derivatives, and as Bloomberg points out in this article…

The banks are preparing to do with carbon what they’ve done before: design and market derivatives contracts that will help client companies hedge their price risk over the long term. They’re also ready to sell carbon-related financial products to outside investors.

Blythe Masters says banks must be allowed to lead the way if a mandatory carbon-trading system is going to help save the planet at the lowest possible cost. And derivatives related to carbon must be part of the mix, she says.

And who, you are probably wondering, is Blythe Masters? Funny story there. She’s actually one of the JP Morgan bankers who invented credit default swaps. Yes, those credit default swaps…the same ones that played a huge role in the near implosion of the global financial system last year. Now Ms. Masters is heading that firm’s carbon trading program, which, it appears, will be built around even more derivatives. Seriously. You can’t make this stuff up, people.

From that same article, and as also highlighted over on Naked Capitalism:

Masters, 40, oversees the New York bank’s environmental businesses as the firm’s global head of commodities…As a young London banker in the early 1990s, Masters was part of JP Morgan’s team developing ideas for transferring risk to third parties. She went on to manage credit risk for JP Morgan’s investment bank. Among the credit derivatives that grew from the bank’s early efforts was the credit-default swap.

Ah, yes. Of course. We’ve got the bankers all wrong. They want to use their powers for good!

This all sounds vaguely familiar, no?

More smug bankers, more hyperkinetic traders, and more toxic derivatives – only this time, they’re all linked to the fate of the entire planet. Brilliant, mate. We’re only one wobbly asteroid away from the greatest Jerry Bruckheimer movie ever…

Great opportunity to convert to a Roth IRA next year. Here’s an article from the WSJ on the new rules:

Get Ready for 2010—the Year of the Roth IRA
Anne Tergesen
Wall Street Journal

New tax rules are about to give more people access to a Roth individual retirement account, one of the most effective vehicles in which to accumulate money for retirement or heirs.

Roth IRAs are currently off-limits to a whole group of people. Individuals with modified adjusted gross income of $120,000 or more can’t contribute to one of these accounts. For married couples, the threshold is $176,000. And individuals with modified adjusted gross income of more than $100,000 and married taxpayers who file separate returns are barred from moving assets held in traditional IRAs into Roth IRAs.

But starting Jan. 1, Uncle Sam will permanently eliminate both the income and filing-status restrictions on transferring money from a traditional IRA to a Roth — a procedure known as converting. So, anyone willing to pay the income taxes due upon making such a move will be able to funnel retirement savings into a Roth, where it can grow tax-free.

Money When You Want It

Under the new rules, high-income taxpayers who wish to contribute to a Roth IRA are still out of luck: Income limitations on funding these accounts will remain in effect. However, Uncle Sam’s decision to allow high earners to convert will give these individuals a back-door way to fund a Roth on a continual basis.

How so? Each year, these taxpayers can open a traditional IRA (which has no income limits) and contribute the maximum (currently, $6,000 for individuals age 50 and older) on a pretax or aftertax basis. Then, they can convert the assets to a Roth IRA.

Why bother with a conversion? Roths have several advantages over traditional IRAs.

Perhaps the biggest one concerns taxes — or a lack thereof. For the most part, withdrawals from Roth IRAs are tax-free as long as an account holder meets the rules for minimum holding periods. If you convert assets to a Roth from other IRAs or retirement plans, you have to hold those assets in a Roth for five years, or until you turn age 59½, whichever comes first, to make penalty-free withdrawals on your converted amounts. Each conversion has its own five-year clock.

Another benefit: no required distributions. With a traditional IRA, individuals are required to begin tapping their accounts — and to pay taxes on those withdrawals — after reaching age 70½. Roth accounts aren’t subject to mandatory distributions, so the money in a Roth can grow tax-free for a longer period of time.

If you are planning to leave your IRA to heirs, Roths have yet another advantage. Although people who inherit both traditional and Roth IRAs must make annual withdrawals from those accounts (based on their life expectancies), Roth beneficiaries owe no income tax on the money.

Tax Bill Upfront

Still, there is a cost to converting to a Roth — namely, the income-tax bill. When you withdraw money from your traditional IRA, you will have to pay income tax on the withdrawal, or, more precisely, on the portion of it that represents pretax contributions and earnings.

In 2010, Uncle Sam is offering taxpayers who convert a special deal: They can choose to report the amount they convert on their 2010 tax returns, or they can spread it equally across their 2011 and 2012 returns. (If you are worried that Congress may raise tax rates, consider paying the tax bill in 2010.)

To determine whether it makes financial sense for you to convert, it’s important to consider various factors. For example, converting may be the right move if you expect to pay higher future tax rates or if the value of your IRA account is temporarily depressed, says Ed Slott, an IRA consultant in Rockville Centre, N.Y. In either case, by converting to a Roth today you’ll lock in a lower tax bill than you would otherwise pay.

To estimate your potential tax bill, first calculate your “basis.” Expressed as a percentage, this is the ratio of two numbers: aftertax contributions you have made to your IRAs (if any), and the total balance in all your IRAs.

For example, if you contributed $40,000 aftertax to your IRAs and have a total of $250,000 in those accounts, your basis would be 16% (or $40,000 divided by $250,000). As a result, if you plan to convert $100,000 to a Roth, 16% of that $100,000 (or $16,000) could be transferred tax-free.

Another factor is how long you can afford to leave the money in a Roth. Because the Roth’s major advantage lies in its ability to deliver tax-free growth from age 70½, the longer you can afford to forego withdrawals, “the more converting plays to your advantage,” says Aimee DeCamillo, head of personal retirement solutions at Merrill Lynch Wealth Management.

Before pulling the trigger, speak to a financial adviser. You also can crunch the numbers using online calculators at sites including RothRetirement.com and Fidelity.com/rothevaluator.

Maximize the Benefit

If you determine that it pays to convert, the following strategies can help you maximize the benefit:

Financial experts say it’s ideal to have money to pay the taxes due upon conversion from a source other than your IRA. That allows you to retain a bigger sum in your tax-sheltered retirement plan.

Keep in mind that you don’t have to convert your entire IRA. It might make sense to do it piecemeal, as you can afford it, over a number of years.

Put converted holdings into a new account, rather than an existing Roth. That way, if the value falls after you’ve paid the tax bill, you can change your mind, “recharacterize” the account (meaning you move the money back into a traditional IRA) and wipe out your income-tax liability.

You have until Oct. 15 of the year following the year of conversion to recharacterize. For example, if you were to convert your IRA to a Roth in 2010, you would have until Oct. 15, 2011 to recharacterize it. Later on, you could choose to convert the assets to a Roth again.

Better still: Consider opening a separate Roth for each type of investment you hold. That way, you can recharacterize the ones that perform poorly and leave the winners alone.

Q. How can I tell if I’m about to make a mistake when investing?

A. The most important thing you can do when buying individual stocks is to have a systematic approach you believe in and use consistently. Another way to avoid mistakes is by understanding investors’ common psychological biases. Here’s an example:

Together a bat and a ball cost $1.10. The bat costs $1.00 more than the ball. How much does the ball cost?

If you answered 10 cents, you choose the most intuitively obvious answer. It’s also wrong.

That question highlights one of a handful of psychological biases that work against investors. A relatively new field of study called behavioral finance examines those biases, including:

1 – Loss aversion. The pain we feel from selling a stock at a loss outweighs the pleasure of selling that stock for a gain of the same amount. When you are deciding whether to sell a stock, ignore the price you paid for it.

2 – Anchoring. All of us have the unfortunate tendency to rely too heavily or ‘anchor’ on specific numbers. Psychologists can easily change the results of simple questions, such as, “How old do you think Clint Eastwood is?” by posing an earlier unrelated question containing a completely irrelevant number, like, “What city is 70 miles south of us?” Don’t get fixated on selling only at a certain stock price.

3 – Confirmation bias. People have an innate tendency to feel smarter about a decision after others confirm it was a good one. Whether or not other people agree with you, though, is irrelevant to investment returns, and it can be harmful.

4 – Recency bias. Most people tend to assume that events of the recent past will continue on into the foreseeable future. The effect of a short-term change in a company’s fortunes can be easily over-exaggerated in the stock market. Thinking long-term when investing helps you avoid this tendency – and take advantage of it, too.

And the correct answer to that question above is that the ball costs five cents. Yes, really. Email me for more.