Bear Stearns had 85 straight years of profits followed by one bad quarter and then a fire sale at $2.30 to JP Morgan Chase, which was increased to $10. (though the mid-2007 catastrophic failures of two big hedge funds, the High Grade Structured Credit Enhanced Leverage Fund and the High-Grade Structured Credit Fund, might have indicated things were a little shaky at Bear Stearns)

Bill Miller, chairman and CEO of Legg Mason Capital, beat the market for 15 years straight before “hitting a wall in 2006.” Since then he’s bad some spectacularly unlucky moves by investing heavily in Countrywide, KB Homes, and Bear Stearns.

Roulette wheels show the history of the spins not because it’ll give players an edge in picking the next number, they do it to entice you to bet. Intellectually, people understand this. Emotionally, they throw caution to the wind if they see five red numbers hit in a row. They’re putting their smart money on black. (then it comes up red again!)

So, if we need to pick a mutual fund and we shouldn’t rely on the past, what should we rely on?

Fees

The one thing you can predict and control about a particular mutual fund is the amount in fees you’ll pay. When selecting a fund, be sure to remember to take a look at the fees involved because they directly impact your rate of return. A 1% annual fee is a 1% decrease off your returns, which can be significant over the court of 40 years. A $1,000 investment that gains 10% each year will be worth $6,727.50 after 20 years, the same fund with a return of 9% a year is worth only $5,604.41 - a 20% difference in value! (and that’s based on a tiny starting investment)

Diversification

How does the fund stack up with your other investments? You need proper diversification to reduce risk and improve returns, so make sure the fund fits properly into your portfolio. While you can’t control the performance of the funds that make up your portfolio, you can at least ensure that you aren’t over-extended in one particular area. While this means that you won’t be hitting any home runs, you’ll be getting more base hits than strike-outs (think Ichiro Suzuki and not Alfonso Soriano).

Returns & Standard Deviation

While past returns are not indicative of future results, that doesn’t mean you shouldn’t pay attention to it! The key, however, isn’t to focus entirely on the returns but to check out the standard deviation of those returns. That will give you an indication of how wide future swings may be and you might not want a fund that can just as easily return 30% as lose 30% (or you do!).

So, when reviewing funds, don’t look just at the returns because they don’t mean much. Look instead at the things you can control (fees and your own diversification).

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The 151st Carnival of Personal Finance (amazing, one hundred and fifty one carnivals…) is available at Alpha Consumer, my post about laddering CD’s at ING Direct was included this week.

As a personal finance blogger, I often write about the importance of an emergency fund but today I want to introduce an idea I call an opportunity fund. The point of an opportunity fund is to have a cash reserve on standby in case you see in opportunity that you don’t want to miss. You fund it with savings, after you’re funded your emergency fund and paid off your debts,

Why A Separate Fund?
One good question to ask is why should you have a separate opportunity fund? Why not just dip into your savings? It’s all about discipline and planning. Much like an emergency, you have no idea when an opportunity is going to present itself. When it does, you’ll want to have the funds around so you can take advantage. If you don’t have a fund, you’ll be scrambling to scrape up the funds and you’re much more liable to make a costly mistake.

For example, let’s say you hear that I am teaming up with Warren Buffett and Bill Gates to start an investment club and we’re looking for $5,000 investments from a hundred people to get started. If you have $5,000 in your opportunity fund, you’re set and you can wire it over to me. If you don’t but really want to get in, you might do something as foolish as put $5,000 on your credit card or liquidate some of your existing assets just so you can get in. Since there’s no guarantee that a Blueprint-WarrenBuffett-BillGates fund is going to turn a profit (it is the stock market after all), you might find yourself in some serious credit card debt! As Confucius once said: “Success depends upon previous preparation, and without such preparation there is sure to be failure.”

Determine How Much
Much like an emergency fund, you’ll have to determine how much you’ll want to save into your opportunity fund. Since these amounts will be put towards an investment of some kind, you’ll only want to put as much as you’re willing to lose in case the investment goes sour. In the investment club example above, if you are willing to go after an opportunity for at most $5,000, then the answer is simple: put $5,000 into your opportunity fund. If you can’t stand the thought of losing $5,000 and can only handle losing $2,000 or $500 then put that amount into your opportunity fund.

You’ll want to make this decision now, now when the opportunity presents itself. Right now you’re balanced, you’re calm, and you’re rational. When you hear that opportunity of a lifetime, you’re likely not going to be any of those three so having a set dollar amount you can lose, decided when you were calm, is going to be valuable as well. Let’s say you decided that $2,000 is how much you were putting into your fund and the investment club demands $5,000 - don’t join. As appealing as the club may sound, it’s out of your price range so just let it go and seek out the next one.

Waiting Game
What should you do with the funds while you wait? Should you put it in a high yield savings account or invest it in the stock market? I recommend that you put the funds in a high yield savings account and let it sit there until an opportunity presents itself. Investing it in the stock market, while appealing from a historical average yield perspective, is an opportunity in and of itself and one that carries risk. Like an emergency fund, you don’t want the risk, so you want to be in a holding pattern until you find the right opportunity (or it finds you). So be patient and put the funds in a place for safekeeping. (If you want to invest in the stock market, by all means do so but recognize that the stock market becomes the opportunity.)

Once you’ve established your opportunity fund, it’s time to go seek out opportunities.

I had a lackluster experience with an alleged financial planner and I’ve read many articles detailing how you should find a financial planner, what you should ask him or her, and everything else you need to do to make sure you don’t a raw deal in the process. I’m sure many of you have read those same articles warning you about how you need to find fee-only financial planners or sleep on their advice. Well, I wanted to highlight a columnist at CNNMoney called “the Mole.” The Mole is an actual practicing financial planner who gives you the full skinny on what you should do to get the right financial planner.

Here are the one’s I felt were valuable reads:

• When you should dump your adviser - some red flags that your financial adviser isn’t up to snuff.
• Are investment newsletters worth it? - “You’d be much better off just throwing the money in the nearest dumpster than buying these newsletters and risking a big chunk of your nest egg in following the newsletters’ advice.” (he’s very honest)
• What a good financial adviser should be doing for you - Discussion on the various aspects financial advisers should help you with.
• Four good questions to ask your adviser
• What your adviser doesn’t know might hurt you

You can find all of The Mole’s articles here.

Last year, the Treasury Department limited the amount of Series I and Series EE Savings Bonds that a US Citizen could purchase in a single year to, effectively $20,000 (TreasuryDirect release). The limit had been $30,000 in paper certificates and $30,000 in electronic certificates for each the Series I and Series EE bonds, meaning you could feasibly purchase $120,000 in savings bonds ($30k electronic Series I, $30k paper Series I, $30k electronic Series EE & $30k paper Series EE) a year ago. The current limit not drops the total amount of savings bonds you can purchase to $20,000 a year (which is still a lot for most Americans).

Why? The stated reason was to “refocus the savings bond program on its original purpose of making these non-marketable Treasury securities available to individuals with relatively small sums to invest.” That is not achieved by lowering the maximum limit, that was achieved when TreasuryDirect allowed you to purchase electronic bonds as low as $25 each.

Another reason was that “Approximately 98 percent of all annual purchases of savings bonds by individuals are for $5,000 or less.” Again, that’s not a legitimate reason to lower the maximum limit. The “it won’t affect that many people” defense won’t work for a lot of things, I don’t see why it’s viable here.

I suppose you could make the argument that lowering the maximum will help those with smaller sums if there was a limited supply of US Savings Bonds. However, if you take a look at our growing debt and growing deficit, you’d be hard-pressed to make the argument that US debt is in short supply.

So why? I’m at a loss and I don’t understand it well enough to make much of an informed guess. I would’ve expected the US government to want to be indebted to its own citizens, rather than foreign interests, so perhaps there is something else going on? I tried searching online but didn’t find any editorials or other insights into why the rate was (really) lowered. Anyone have any thoughts?

Incidentally, the Treasury announced the new rates and the fixed portion of the Series I Savings bond dropped from 1.2% to 0.00%!

I don’t know if TreasuryDirect changed their policy or if EmigrantDirect changed theirs, but my attempt to purchase Series I Bonds and take advantage of the potentially awesome new rates was foiled! I received the following message from TreasuryDirect:

Dear JIM,

We’re sorry, but your purchase request IAAAB was canceled. While trying to collect payment from your bank, they returned our debit. Please check the Investor InBox section of your TreasuryDirect account for more detailed information.

Thank you for using TreasuryDirect.

It was entirely my fault. It wasn’t Emigrant Direct’s fault, or the Treasury Direct’s fault, it was Jim Direct’s fault. The only linked account I had was from an Emigrant Direct savings account and I assumed it would still be valid to make another purchase. I had purchased $100 in Series I bonds a while back just to play with the system and assumed everything was still good. Unfortunately, TreasuryDirect now debits the linked account rather than a regular ACH transfer (I think) and so a savings account doesn’t debit! (The other explanation was that there were insufficient funds, but I confirmed I had enough)

So the only solution is to head over to the bank and buy a paper Series I Bond so I can still take advantage of the upcoming favorable rates. I suspect it should be pretty easy, the government always makes it easy for you to give them your money :).

If you’re a buyer of Series I Savings Bonds, you probably already know this. If you haven’t been paying much attention to them, it might be time to perk up because Series I bonds are looking pretty good given right now. So good that I decided to purchase some of them.

Opening Treasury Direct Account

Fortunately, I opened up a Treasury Direct account a while back and had my bank account linked up so I could skip the setup process. I don’t know if the setup process still only takes five minutes, as I had written, or if it was more complicated now. I do know that Treasury Direct will be sending out new access cards for security purposes, so perhaps the setup process is a little more involved now. Regardless, I was able to find my login credentials (if you lose them, getting your ID requires a tremendous amount of information, the government doesn’t mess around)

If you aren’t familiar with Series I Bonds or Treasury Direct, you can review this primer on them, it should get you up to speed. Everything is still accurate except the annual limit per SSN has been lowered from $30,000 to $10,000 ($5k online, $5k in paper).

New Rates

The Series I Bonds’ interest rate is calculated through a fixed rate and a semiannual inflation rate. The fixed rate is announced every May and November and is valid for all bonds issued during the six month period after the announcement and is valid for the life of the bond. Last November, the announced fixed rate was 1.20%. The inflation portion is also announced every May and November and is based on the CPI-U (Consumer Price Index for all Urban Consumers) and can be reasonably predicted. It’s predicted that the announced inflation portion of the rate will be approximately 2.416%.

If you take that to be true, using the total rate calculation, you’ll get an annual rate of 6.06% - which is nearly double most online savings accounts. That’s why we’re getting some Series I Bonds. By purchasing in April, we lock in the fixed rate portion of 1.2%. This gets us 4.38% for six months then 6.06% for another six months, with the future unknown. What’s nice is that the interest is federal tax deferred (until you cash in the bond) and state & local tax free, so the effective rate is a little higher depending on your state taxes.

Redemption Rules

The only important rules about Series I bonds is that you can’t redeem them for one year and if you redeem it before it’s five years old, you surrender 3 months of interest (most recent three months). Also, in case you were interested, savings bonds are nontransferable so don’t buy them off anyone. And lastly, when you redeem the bonds you will receive a 1099-INT.

If you want more information, here’s the Treasury Direct page on Series I Bonds, which includes a list of historical rates (fixed and inflation) as well as the equation they use to calculate the composite earning rate.

(photo by allyrose18)

If you ever wanted to buy shares of L’Oreal, you probably were introduced to the idea of an American Depository Receipt. American Depository Receipts, or ADRs, are constructs that allow you to purchase ownership interest (stock) in foreign companies on the domestic stock market.

It’s actually a pretty simple construct. The ADR is a certificate issued by a US depository bank and represents a share (could be a fraction, whole, or multiple shares) of a foreign stock the bank is holding overseas. The ADRs are issued in terms of US dollars but the underlying security is still held in the country of origin’s currency. The whole point of ADRs is that it makes it easier and more convenient to own foreign shares. Instead of having to open a brokerage account overseas, transfer the funds, convert them into the local currency, and then make the purchase - you just buy an ADR. (that’s just one-way, so double that headache). You can tell if a stock is traded as an ADR because it will generally have (ADR) next to its name (as L’Oreal does on Google Finance).

From the operations perspective of yourself, the investor, there is no difference between buying and selling shares of stock and ADRs. You just need to be aware that in addition to all the risks associated with investing in the domestic stock market, you’re introducing currency and country risk into your portfolio. Currency risk refers to the exchange rate of the dollar and the local currency. Country risk refers to the risk associated with changes in the local country’s economy. In the domestic stock market, all holdings are in dollar and you’re contained within the US economy (for the most part, though the World Is Flat) so you don’t have to account for currency and country risk (from the local country).

(If you want to get technical, an ADR is the actual certificate where as an American Depository Share, ADS, is the actual share. An ADR can represent multiple ADSs. In colloquial use, ADR refers to both.)

According to Wikipedia, the first ADR was introduced by JPMorgan in 1927 for a British retailer named Selfridges&Co. The largest depository bank is the Bank of New york Mellon.