10/31/2008 05:12 am ET Updated May 25, 2011

A Bailout for Index Funds? Not Likely

Wall Street as we knew it has disappeared. A huge bailout may happen. This is a fine time to assess what works and what doesn't.

Here is a list of some of the biggest names in the index fund world. I call it the "good" list.

State Street
Dimensional Fund Advisors
T. Rowe Price

Here is a partial list of troubled firms that have been affected by the recent financial meltdown. You can guess what I call it:

Goldman Sachs
Morgan Stanley
Bear Stearns
Merrill Lynch

Many observers believe this is only the tip of the iceberg.

It is not entirely surprising that the shocking lack of competence of these firms resulted in their downfall. One study found that 94% of 50 major brokerage and investment banking firms continued to recommend investors buy or hold shares in failing companies right up to the day those companies filed for bankruptcy.

None of the firms on the "good" list need a bailout.

These firms sell investment products everyone can understand. They use a benchmark. The fund tracks the benchmark and captures the returns of that benchmark, less low transaction costs.

Their products don't have "sizzle"--unlike complex financial instruments like collateralized mortgage obligations, initially created for the defunct Freddie Mac.

The boring firms are now in the position of bailing out the really exciting ones.

What we are witnessing is more than the restructuring of Wall Street. It should also fundamentally change the way we invest and the kind of information upon which we rely.

Even the most committed returns-chasing investor must pause and reflect on a system in which trusted sources of investment advice have been so wrong. One of the most egregious examples is Standard & Poors analyst report on Washington Mutual issued September 24, 2008, one day before WaMu was taken over by the FDIC. Its deposits were sold to JP Morgan. The report advised investors to "hold" the stock and set a 12 month "target price" of $4 a share.

WaMu is currently trading at 16 cents a share.

The silver lining in the dark clouds is that the new paradigm for investors is so clearly in their best interest.

Just because the government is thinking about bailing out Wall Street doesn't mean you have to continue to follow suit.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.