Alright, I’ll veer a little from my usual credit card rant. But this is something I have to get off my chest.

The Wall Street earlier this week finally published an a fact that I’ve known since the end of January this year – which is the S&P index has essentially been flat this decade. YES, you’ve heard it right, it has been flat this decade.

Which brings us to an interesting question? Are index funds as great as they are made out to be? Index funds obviously have their advantages. They are low cost and tax efficient. However, the main disadvantage is that they follow the market and an investor in an index fund essentially assumes market risk.

There have been many raving fans of index funds in the pf blog world. For example, Free Money Finance wrote a few posts on why he likes index funds. Advanced Personal Finance also recently posted his IRA asset allocation on the blog. Moolanomy has also written about the virtues of having index funds as a sensible strategy. The Simple Dollar (an influential voice in the personal finance space) is also a huge fan of index funds

Supporters of index funds will insist that most (or rather the average mutual funds fails to beat the S&P index over the long run). While that may be an important statistics, they disregard the fact that most funds should never be compared to the S&P index. A large cap value fund for example, should be compared to the large cap value index (perhaps a Russell 1000 value index). But the biggest problem with index investing is that is the market is negative or flat, you perform as in line with the market. For a young person or couple, one might argue that one can ride it out in the “long term”.

However, you may not have a “long term” horizon! How is that so? Well, imagine that you were 55 years old in 2000 and you plan to retire when you are about 62 or 63 years old (2008?). Back in 2000, you did some financial planning and you decided on an asset allocation model and implicit in that model is the fact that you would expect stocks to achieve an ‘average return’ of about say 8%. Your financial planner decides to get you invested in a Vanguard S&P index fund because of its low cost. Well, the results weren’t too pretty.

Or imagine that you retired in 2000! I’m sure many folks did. Once again, let’s assume that you sat down with a financial planner and figured out an asset allocation model which should enable you to achieve your desired standard of living. But I bet that for most folks who retired in 2000, they would have to adjust their lifestyles. The S&P declined about 40% from peak to trough in the early 2000s. Now try telling these retirees that index funds are great!

The fact of the matter is this : Absolute Returns DO Matter – not relative returns. It’s no use saying that your portfolio declined 30% in the early 2000s and be happy because it outperformed the S&P!.

The other problem with indexing in general is that most indexes are weighted by market capitalization. This presents a problem because as the market rallies, you end up ing more expensive stocks! So as you were dollar cost averaging into a typical S&P index fund in early 2007, you were ing over 35% of financials (which was the weightings then – it is now lower). Or consider that in the late 80s if you bought an EAFE index (for international investing), 80% of the then EAFE composition was in Japanese stocks. And they now comprise only a fraction of that. Hence, you would have ended by ing Japan at inflated prices! But hey indexes are the way to go and they are low cost!

But can you on hindsight pick funds that will put you ahead? Well, there are funds that would have given you positive returns this decade (talking about large cap funds – since the S&P is a large cap index). And anyone could have picked these funds in 2000s. The thing they had in common even in 2000 was a 10 year track record. Here are some gems :

For those of you value believers

Eaton vance Dividend Builder A

Dodge and Cox Stock – a favourite.

American Century Equity Income

General Large Cap Stocks

American Funds Fundamental Investments – Hey – it’s American Funds.

Davis New York Venture – which is actually a value fund that has been categorized as large blend by Morningstar.

The reason I wrote this post is that I think too much credit has been given to index funds and not too many posts have been written on risk versus returns. With an index fund, you are essentially accepting market risk. But the biggest danger to long term wealth is actually the volatility of your portfolio. Obviously, you could lower the volatility of your portfolio with proper asset allocation. But most posts written on the web and even in mainstream publications always encourage a large portion of your investments to be in stocks because “in the long run”, they outperform most other asset class. Well, from the peak of the stock market in 1929, it was not until 1054 that the market was essentially at the same levels (yes more than 2 decades). From the peak of the early 70s, it wasn’t until 1985 that the indexes caught up with those levels. And now, it’s been flat for 9 years since the beginning of the new century. Like I said, if you are in your early twenties, time is on your side. But the those in their 50s or nearing retirement age, you have to think long and hard about their investment strategy.

And I suggest that one takes a long hard look at the assumption that index funds are the end all and be all. They obviously have a place in your portfolio and I’m not saying it’s bad. But too little has been written about their downsides.

I wrote a post yesterday about how Mrs Credit Card and myself spent the whole day doing our taxes. After the exhausting day, I sat down in the evening and reflected what I have done right in my finance organization and what I could have done better.

There a some things that I am pleased to have implemented. One is that our bills are automatically deducted from our bank accounts. Our utilities are charged to our credit cards so that we can earn more rewards points or cash rebates. We contribute to our retirement plans and also contribute to savings in our taxable accounts.

What we have not done so well is to budget specifically for certain items. For example, we had a basement leak early in 2007 which set us back $6,000. That was an unexpected expense. We also took a few vacations last year which we did not budget. But we still managed not to dig into our savings plan or incur any debt.

I also realized that I hate actually sitting down in front of a spreadsheet and budgeting. I have to force myself and find the right time to sit down and actually do some budgeting and monitor our finances. What also tends to happen is that occasionally, Mrs Credit Card would go on a little shopping binge.

At the beginning of last year, I asked Mrs Credit Card to take more time looking at our budget. She did not exactly take it to mean that she was in charge. She volunteered to categorize my work receipts (which I have failed to hand it to her on time). However, there were many times when she expected me to sort out our mails and I wondered my she couldn’t do it. There were also other times when I asked her how we were on the budget and she said she has not looked at it for while!

After doing our taxes almost in the last minute (not a deadline last minute), I came to realize that one of us has to take over the role of a CFO in our household. And I think that person will not be me but Mrs Credit Card. The reason is that I hate doing mundane things like filing my receipts, checking our expenses etc. I would like that to be done and presented to me! (like a CEO!). But I’m sure Mrs Credit Card will accept the role, but she also has to look after our 3 kids . And she has a couple of other sites that she runs! So what gives.

I think we might have to hire a part time book keeper. Or if we decide not to do so, one of us (more like Mrs Credit Card) has to assume the full role of our household CFO position and be in charge of everything, from budgeting, monitoring our expenses, reporting, checking our mails, filing our receipts and forms and all that stuff. I’ll let you know of the outcome of this, but I certainly feel that our present situation where we both sort of look at our finances together, but not being as engaged as we should be is not the ideal situation.

Share your thoughts on this here.

I thought that I would never really make the deadline for this carnival of debt reduction. John told me earlier this week that I would be hosting and I did not really find out until friday that Mrs Credit Card arranged a trip to New York until Monday to get away for the kids spring break! I was tempted to send John an email asking if someone would swap places with me. While I could put together the carnival quickly if I decided to, I had always put in some effort into making a carnival interesting if I was hosting it. Furthermore, people who have been hosting carnivals are getting more creative in terms of having themes and even lots of photos!. But I decided to shoulder on.

So here I am writing on a Sunday night after visiting the Museum of Natural History with the kids the whole day. My feet are really hurting so I did not mind spending some time on the laptop. After logging onto the hotels internet access and paying $9.95 for 24 hour access, I suddenly realize that I did not have much time. Plus I was getting really tired. And I have no theme! So here is my ramble, and I hope the pieces do fall together.

Bears Stearns in Trouble?

One of the events that stuck to my mind this week was the fact that on Monday, a couple of friends of mine who work on wall street’s bond departments told me that Bear Stearns credit default swaps were trading at 900 basis points. Essentially, they were trading at distressed levels. On friday, Bear’s stock collapsed despite getting emergency funding through JP Morgan. Funny things was how the bonds guys knew this might happen and the stock trading community did not know about it until it was too late. If we look at our own lives, perhaps there are signs that we can gather if we are heading towards a financial disaster. How to Know if You’re in Deep Financial Trouble by Terry of Savvy Frugality is a good check list for yourself.

Diversify Your Revenue and everything!

Bear Stearns is likely to be put on the block for sale and part of the reason is that they did not diversify their revenues when things were great the last few years. While most investment banks are have thriving bond, stock and investment banking departments, Bear’s strength is mainly in bonds (and Mortgages!). The lesson here is that one has to diversify one’s revenue stream so that you do not become too cyclical with the economy. Applying that to a personal level, PT presents 12 Ways to Make Yourself Recession-Proof posted at Prime Time Money. Another important lesson comes from Steve Faber who says that simply reducing expenses is not enough. We also have to “grow our revenue” and he encourages us to enroll in – Continuing Education Certificate Programs to Earn Extra Money.

Where’s the risk management tool?

But Bear’s story is just the latest news headlines that have hit us since last summer when the sub-prime crisis first unraveled. It started to really make headlines when Merrill Lynch, Citibank and in fact all big banks announced massive write downs on the mortgage securities. Given the amount of write downs, it makes you wonder how banks look at their risk. Aren’t they sophisticated enough? Haven’t they looked at their total risk profile. Worse to come, AIG also announced massive writedowns. Bill Gross from PIMCO described this whole fiasco as the unwinding of the “shadow banking system”. The equity analyst also did not anticipate this because many of these securities were derivatives held “off-balance-sheet”! I guess the lesson is that there is no such thing as off balance sheet items. You have to look at everything as InvestorBlogger writes in his blog aptly titled Is your bank book your financial statement?.

Speaking of risk management systems, it is clear that today’s financial institutions have been found wanting in this area. To be fair, it is a very complicated area as many loans and securities today are modeled by PhDs! For us mortals, our situation can get complicated but fortunately, we do not need rocket scientist to figure that out. There are lots of tools available and they all serve their purposes. Here are a few reviews and thoughts on the latest tools.

Millionaire Money Habiits writes about mvelopes personal finance software review

Pete presents 3 weeks with Geezeo.com – A Review posted at Bible Money Matters

Kevin presents No Debt Plan » Blog Archive » Budgeting Tools posted at No Debt Plan.

Hire the Best – Fire the Crap

When Merrill Lynch and Citibank announced massive losses on their sub prime securities, their CEO took the heat for that. And rightly so. When John Thain came to Merrill, he opened said in interviews that their risk management system could be improved upon. That must have been the understatement of the year. We have to give kudos to Merrill to looking outside and hiring someone with better risk management background. In the same spirit, The Happy Rock has just fired himself as his own CPA! and now Spends The Big Money For Tax Prepation.

History Always Repeats Itself

In 1998, Long Term Capital blew up when liquidity dried up and all their trades went sour and they could not unwind them. They were also high leveraged. You would think those lessons have been learned, but we all know history always repeats itself. Recently, Carlyle Capital has gotten into trouble because of margin calls and over leverage. And to think that they were some of the smartest guys in private equity. Here are a few posts that reminds me of this.

nickel presents Seven Deadly Sins That Lead to Debt posted at fivecentnickel.com.

Ryan Healy presents Why People Stay in Debt posted at Debt Reduction Formula.

debt freedom fighter presents Money, Mathematics, and Personal Behavior – Dave Ramsey is Right! posted at Discover Debt Freedom!.

Why Minimum Monthly Payments Will Cost You Big advice will always be ignored by most.

Would Carlyle have learned anything by reading these articles? ha – probably not. But once again, to folks like us, I would devour every word of these.

Over leverage is dangerous

A major reason of the mess that we are facing is simply the amount of over leverage in the system. From financial institutions to hedge funds and to us as individuals. Financial institutions have “off balance sheet” items (which are legitimate). Individuals as well got over leveraged because we could get 0% downpayment, get our brand new plasma TV with our HELOC! Warren Buffet used to describe an LBO as putting a dagger on the steering wheel. It makes you careful (debt makes you efficient!), but one accident and that’s it. The lesson here is do not set yourself up such that you have a razor thin margin for error. Here are a couple of posts that relates to that.

paidtwice presents Don’t Set Yourself Up To Crash and Burn – Wiggle. posted at I’ve Paid For This Twice Already….

Randy Peterman presents The Moved Buffer Theory Budget posted at Watch My Money Maker.

But how this all this happened?

After the fact, every financial journalist began to talk about how this whole sub prime mess cam e about. Easy financing, new debt securities that carved and tranched risk into different risk profile and then sold them off to investors. Because of the investors huge appetite for risk, underwriting standards become lax. This is all good and well writing on “hindsight”. insert : : Here’s an interview by Emily Starbuck Gerson with Debtors Anonymous!

Problem is why didn’t anyone foresee this years ago? Maybe it is time we looked at some trends in the personal finance world that might get us into trouble these days. For example, FMF has warned us to Be Careful with Home Equity and 401k Credit Cards. Actually, he did not even write this post! But I’ll let him get away with it since he got a good guest blogger.

To mark to market or not

Since AIG had to announce a massive $11bn write down, they have made noises and arguments against “fair value accounting”. In fact, there has great amount of debate about this recently. While investment banks and hedge funds have to “mark to market”, banks and insurance companies can shift their declining assets into their “long term and hold books”. Part of the debate going on now is whether having to mark to market in a declining market actually makes things worse since everyone has to sell in a falling market which sets a spiral. However, the other side of the argument is that the Japanese banks were not required to mark to market in the 90s and they took ages to finally get around their bad debt problem. As far as folks like us are concerned, we are marked to market and it is for the better. In the spirit of full disclosure, Aryn discolses February Debt Reduction Process at Sound Money Matters

Not everyone was hurt

Despite the market action during the last six months, not every hedge fund or money manager was hurt. Paulson fund was a standout. He correctly anticipated the sub prime mess and was massively short short prime related securities. His funds were up a few hundred percent and one of them was up about as high as 500%! Who says manages cannot beat the S&P. His 2007 performance alone means he can lag for as long as he wants going forward! In the spirit on Paulson’s fund outperformance, here are a few stand outs from this weeks submission.

Vicki is now credit card debt free.

Ana presents Debt Reduction Success Story in Army Times posted at DebtFREE-Revolution. Debt Reduction of $90,000 in one year! That has to be equivalent to Paulson’s 500% return last year!

Debbie tells us how How She Got Out of Credit Card Debt.

Take Action – Replenish Capital with Sovereign Funds

So far, we’ve already have had a big big financial institutions replenish their capital from investments from Sovereign funds. Merrill Lynch, Citigroup, UBS have all had foreign investments to shore up their capital. Congress may get jittery about this but these banks did the right thing because having adequate capital in times of a liquidity crunch is vitally important. Mr. Debtbeater recently Cut Up His Credit Cards. Hey, if that is what it takes, so be it.

Deleted Scenes

Well, even George Lucas had to delete tons of scenes from his final movie and unfortunately, here are some posts that can’t fit into the movie (or could it be that it is midnight and I’ve no desire to stay up any longer!). But at least, these post are still in the collectors DVD!

Dividend Money Presents student loan reduction strategy

Amanda presents 4 Credit/Debt/Money Documentaries

Squawkfox presents Rent vs. Buy Calculator

Erek Ostrowski presents Getting Out of Debt (Part 1)

Bear sells out for $2

Just when I thought I could go to bed, the news is out that Bear has sold itself to JPM for just $2 a share! What more can I say?

Well, morality aside, I think there are important lessons to be learned in this whole Spitzer saga. While most people are asking how can Mrs Spitzer stand beside her husband after what happened, little has been written about how and why people will shell out $1000 an hour or $4,300 a pop on the services by an “escort” (to put it politely).

This is no different from asking why some lawyers get away from charging $900 an hour versus $250 for others? And I think there are important lessons for those who are in the service industry where you have to “bill” for your time.

But before we answer that, let’s try to put our heads in the mind of Mr Spitzer. What value was he getting from paying $1,000 an hour (not counting the cost of her train ticket etc).

1. A person of Mr Spitzer’s stature wants his dealings with prostitutes to be “highly discreet”. He cannot be seen looking for them in the streets. They have to come to him.

2. Emperor’s club is marketed as “high class service”. Hence, Mr Spitzer would expect his escort to be better dressed and discreet looking compared to most of Kristen’s “peers”.

3. Because someone like Mr Spitzer cannot be caught in the act, he would expect emperor’s club to be super efficient in organizing the whole “package”.

In a nutshell, Mr Spitzer wants to have a good time with a hooker discreetly and for someone of his stature, there is a price for providing such a service!

The moral of the story is that when you are targeting the high end market, there are other intangible factors (other that product performance!) that the segment values and are willing to pay for.

In the credit card industry, most credit cards do not charge any annual fee. Yet, cards like the American Express Black Centurion Card (which has a $2,500 annual fee and a $5,000 activation fee!) exists. The American Express Platinum Card has a $450 annual fee. Their gold card has a $150 annual fee.

How is it that one of the most popular combination of credit cards of frequent travelers is the Amex Black or Platinum Card with the Starwood Preferred Guest Credit Card even though these cards charge annual fees unlike most cards? The answer lies in the many little benefits that are simply not available in regular credit cards.

1. Concierge service – Amex used to be the only ones to offer this service on their charge cards. But these days, many visa and mastercards offer this too. However, Amex allows you to have your own personal concierge who can get to know you and provide more personalized service.

2. Ability to book hard to get restaurants – Having a Amex Platinum or Black card makes it easier to book hard to get restaurants.

3. Priority notices to popular events

4. Having the best reward program – in my opinion, Amex has the best reward program in membership rewards and I think they can get away with charging a fee for this.

5. Starwood has the best collection of 5 star hotels – let’s face it – a successful executive does not stay at the Hyatt or Hilton!

6. Prestige – we all judge a book by its cover. A man’s clothes maketh a man! Carrying an Amex Platinum or Black card is indeed a status symbol.

I can go on and on about examples in other industries but the moral of the story here is that there is always a lucrative market in the high end segment. More often that not, “product performance” is not really the differentiating factor. But other intangibles often allows one to charge higher prices as long as you meet the market’s needs. These needs have more to do with attributes like personalized service, making your clients feel important and other “high touch” service not available in average products.

So whether you are a web designer, a consultant, a mineral water manufacturer, branding and identifying the right attributes that the high end segment of your market craves can often bring great rewards if you find the right “package” and “value proposition”. Hey, after all, Mr Spitzer paid $1,000 an hour and I bet it wasn’t pro-rated if it was over in 10 minutes!

Acquiring home improvement tools – an idea for neighborhood non-proprietary minded male friends

“Wow, so many tools and so little money to them”. Yes there are great cards that help with cash back on purchases at Home Depot and low interest rates but do I really want to more tools that fill up my garage? Well yes and no.

Having international friends now living in the USA who have not been raised in the American culture of home improvement and obsessiveness about tools to address every possible home maintenance need, I am amazed when I look in their garages. They are completely devoid of home maintenance and improvement tools and such. And although I don’t quite see how they can survive in suburbia without the essential hedge trimmer and workbench of tools, It makes me realize that there must be a better way than to keep acquiring more tools that fill up my garage.

They have relatively no tools, and are perfectly happy to keep it that way. Yes, you might say “just call a plumber or electrician or handyman”, but we know that it is cost of labor, not the cost of tools that keeps the do-it-your-selfer engaged in such activities. In fact, for many, it is the cost of labor that helps one justify the expense of more expensive labor saving tools and devices at Home Depot.

We all have close neighborhood friends who all struggle with the issue of acquiring 1-time-use tools and storing them for a lifetime – right? Well, what to do?

I’ve decided that if we are all in agreement, to start an inventory list of tools that we can publish to each other, it would reduce our number of trips to Home Depot, save gas, time and the probability for excessive tool acquisitions. I’m going to propose this to my friends and see what they think. We’ll all have to be ok with allowing others to borrow them and there needs to be some ground rules of course. I’ll let you know what happens and then start building an inventory list. Any thoughts on this?