Dimensional Fund Advisors

Dimensional vs Vanguard

Dimensional Fund Advisors

We are sometimes asked what the difference is between Vanguard, ETFs and DFA Index Funds. The short answer is: they use different indexes. DFA has custom designed their indexes to capture the risk factors that explain 96% of stock market returns, going back to 1928. Those factors include company size (market capitalization) and value (based on the company's Book Value divided by its Market Capitalization, or Book to Market Ratio (BtM)).

Here are a few charts explaining why IFA prefers to advise clients to invest in DFA funds over Vanguard.

These differences in fund returns are explained by the difference in small and value tilts of the funds. When we assemble diversified portfolios and scatter plot the data, the chart below shows the combined impact of these fund differences based on risk and return.

Passive advisors play an integral role in emotions management. Knowledgeable, passive advisors help maximize investor success because they provide the critical discipline needed to combat emotional, reflex reactions like pulling out of the market the way so many did in late 2008, early 2009, or in 2011. Passive advisors not only help to manage an investor's emotions, they serve as fiduciary stewards of their clients' wealth.

The chart below is a compilation of 20 studies which depict varying levels of investor success with or without passive advisors. It shows that the average fund investor without a passive advisor (blue bars) captured only an average of 50% of fund returns. Indexers without passive advisors (purple bars) were more successful at capturing fund returns than average fund investors, due to a less active approach. However, they also failed to capture the full returns of the index funds they owned. The average passive investor captured only an average of 79% of a fund's return, according to the studies. This is likely explained by a failure to rebalance asset allocations during market turbulence, a delay of investing when cash is available, or even the inability to stay invested during rocky markets. In contrast, Don Phillips, who was the Managing Director at Morningstar concluded in the 2005 Morningstar Indexes Yearbook that individuals who invested in Dimensional Fund Advisors (DFA) funds and used passive advisors (green bar) captured all of the fund returns and then some—105% of the fund returns. A 2005 Morningstar report says, "Consider the success Dimensional Fund Advisors (DFA) has had in selling its funds through advisors who undergo training on the merits of passive investing and in portfolio construction theory. Consider that over the past decade the dollar-weighted return of all index funds was just 82% of the time-weighted return investors could have gotten with those funds. Yet, the figures for DFA are much better. In fact, the dollar-weighted returns of DFA funds over the past 10 years are actually higher than their time-weighted returns, suggesting advisors who use DFA encourage very smart behavior among their clients, even buying more out-of-favor segments of the market and riding them up, rather than buying at the peak and riding the trend down, which is usually the case with fund investors."

 

 

The findings of this Morningstar report are shown in the table below.

Knowledgeable passive advisors help their clients stay invested and rebalance through market turbulence. Such behavior enables these investors to maximize their ability to capture returns and provides justification for the right passive advisor. Many investors are lured into do-it-yourself indexing through exchange traded funds (ETFs). This is a step in the right direction, but without a passive advisor, these investors have not experienced the full value of advised indexing. Quality passive advisors offer valuable services, such as rebalancing, tax loss harvesting, a glide path strategy, and other wealth management tools that are rarely properly applied by do-it-yourself investors.