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Choosing The Right Investment Strategy, Part I

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There is an enduring debate about active versus passive management.

There are advantages and disadvantages to each strategy that investors should consider.

In this series, I will provide investors with an overview of the various strategies, and provide information that will help them select what is best for them.

I will explore Passive Investing in this piece, followed by various forms of active management in Part II.

The enduring debate among financial practitioners is whether active or passive management of portfolios is best. In this series, I want to go over four main strategies, and explore in detail the pluses and minuses of each, and who benefits most with each strategy. With this information in hand, you can be better able to select the strategy that works best for your specific situation, or, if applicable, that of your client.

Strategy 1: Passive Management

Objective: The passive investor would argue that markets are efficient and thus there is no use in trying to beat them. Thus, the objective of passively managed funds, is to buy all the stocks in a particular market, such as the S&P 500, and track the performance of that index. Because we have no way of knowing which stocks will beat the market and which will not, the passive investor would reason, you are better off buying the entire market at a very low cost, and taking the return provided by ‘the market’.

Best For: Passive investing is best for investors who want to track the market at a very low cost, and are not concerned with beating the market. Passive investors simply own the whole market, and receive the return of the index, minus any expenses.

Advantages: The advantages of passive investing are many.

  • The strategy is supported by many Nobel Prize winners, and highly successful investors. Research continues to support this strategy because of the poor results of active management, and because of the research demonstrating that markets are efficient. (1) More information supporting this conclusion is included in the ‘Further Research’ section.
  • Research by S&P, included in the ‘Further Research’ section below, demonstrates that over long measurement periods, active managers have a difficult time beating the passive index, which means that instead of obtaining average returns from passive investing, the index fund is actually obtaining very high returns relative to their active fund peers. (2)
  • Additional research by the S&P, included in the ‘Further Research’ section below, demonstrated that for those funds that do beat the index, it was very difficult for them to continue to do so from one year to the next. (3)
  • By buying the whole market, your returns tend to correlate to the market averages, with little or no tracking error.
  • In addition, index funds, can be purchased at rock bottom fees as low as 0.04%. The less you pay in fees, the more you have available to take advantage of compounding over time. Every dollar paid out in expenses, loses the ability to compound and add to your wealth over time.

Disadvantages: The disadvantages of index funds are:

  • You are buying the whole market, which means you own some really great companies and some not so great companies.
  • Additionally, because you are tracking an index, you are guaranteed to underperform the market every year after costs and expenses.
  • Index funds also do not give any consideration to the prices they pay for securities. Because traditional index funds are weighted, by market capitalization, as stocks get larger and more expensive they make up more and more of the index. This seems counter-intuitive to the very principles of investing, which tell investors to buy low and sell high.
  • There are many structural issues with index funds, such as their inability to act like owners and represent the interests of shareholders. Research continues to prove that index funds vote with management the majority of the time as you can see in the ‘Further Research” section below. (4)

Further Research

1. A Sampling of Research Supporting Market Efficiency

– George Gibson (1889) wrote the book, “The Stock Markets of London, Paris, and New York,” mentioning the concept of efficient markets. Gibson wrote, “when shares become publicly known in an open market, the value which they acquire may be regarded as the judgment of the best intelligence concerning them.”

– Fama (1965) defined an efficient market for the first time in his empirical analysis of stock market prices in which they conclude that they follow a random walk.

– Samuelson (1965) provided the first real arguments for efficient markets in his paper, “Proof,” that properly anticipated prices fluctuate randomly.

– Fama et al. (1969) undertook the first ever event study (although they were not the first to publish), and their results lend considerable support to the conclusion that the stock market is efficient.

– Published in 1970, the definitive paper on the efficient markets hypothesis is Eugene F. Fama’s first of three review papers: ‘Efficient Capital Markets: A Review of Theory and Empirical Work’ (Fama, 1970). He was also the first to consider the ‘joint hypothesis problem’. Granger and Morgenstern (1970) published the book, “Predictability of Stock Market Prices.”

Scholes (1972) studied the price effects of secondary offerings and found that the market is efficient except for some indication of post-event price drift.

Ellis (1975) published the article, “The Losers Game,” in the Financial Analysts Journal. The investment management business (it should be a profession but is not) is built upon a simple and basic belief: Professional money managers can beat the market. That premise appears to be false.

Malkiel (2003) examined the attacks on the EMH and concludes that stock markets are far more efficient and far less predictable than some recent academic papers would have us believe.

Malkiel (2005) showed that professional investment managers do not outperform their index benchmarks and provides evidence that by and large market prices do seem to reflect all available information.

2. Research on The Failure of Active Management

The 2017 SPIVA Scorecard demonstrated a consistent long term trend that active managers, in the aggregate, have trouble beating the index.

“over the 15-year investment horizon, 92.33% of large-cap managers, 94.81% of mid-cap managers, and 95.73% of small-cap managers failed to outperform on a relative basis.”

The 2016 SPIVA Scorecard has put together an excellent analysis showing that active funds do not beat the index. It states:

“Given that active managers’ performance can vary based on market cycles, the newly available 15-year data tells a more stable narrative. Over the 15-year period ending Dec. 2016, 92.15% of large-cap, 95.4% of mid-cap, and 93.21% of small-cap managers trailed their respective benchmarks.”

2015 SPIVA Scorecard Results:

3. S&P Research on Persistence

Fleeting Alpha Evidence from The SPIVA and Persistence Scorecards”

“out of 1,034 large-cap funds that existed in the universe as of Sept. 30, 2013, only 19.73%, or 204 funds, outperformed the S&P 500®. In the following year, 15.69% of those 204 funds outperformed the benchmark. By the end of the third year, none of those original 204 funds were able to outperform the S&P 500 on a consecutive basis.”

4. Research on the Structural Challenges of index funds

It may be said, with some approximation to the truth, that investment is grounded on the past whereas speculation looks primarily to the future, but this statement is far from complete. Both investment and speculation must meet the test of the future; they are subject to its vicissitudes and are judged by its verdict. But what we have said about the analyst and the future applies equally well to the concept of investment. For investment, the future is essentially something to be guarded against rather than be profited from. If the future brings improvement, so much the better; but investment as such cannot be founded in any important degree upon the expectation of improvement. Speculation, on the other hand, may always properly-and often soundly derive its basis and its justification from prospective developments that differ from past performance…The individual investor should act consistently as an investor and not as a speculator.” – Benjamin Graham, Security Analysis

When you look across the index universe. The top three index providers are owning more and more of corporate America, giving index funds more power over shareholder proposals. This has real consequences for capitalism that more investors should be concerned about.

“Every new indexed dollar goes to the same places as previous dollars did. This “guarantees that the most valuable company stays the most valuable, and gets more valuable and keeps going up. There’s no valuation or other parameters around that decision,”… the result will be a “bubble machine”-a winner-take-all system that inflates already large companies, blind to whether they’re actually selling more widgets or generating bigger profits. Such effects already exist today, of course, but the market is able to rely on active investors to counteract them. The fewer active investors there are, however, the harder counteraction will be.” – New Yorker Is Passive Investment Actively Hurting The Economy?

2017 paper looked at the effect the big three – Vanguard, BlackRock (NYSE:BLK), and State Street (NYSE:STT) – have on corporate ownership and the creation of new financial risks for capitalism. The authors from the University of Amsterdam explore the challenges with passive investing being concentrated in a few firms, versus the advantages of competition and the fragmentation of active investing. Because active investing is more fragmented, it results in corporate ownership being spread around to dozens upon dozens of firms. This prevents any one firm from having potential undue influence over corporate management.

The authors state:

“When we talk about the power of large asset managers, we are concerned with their influence over corporate control and as such their capacity to influence the outcomes of corporate decision-making. Shareholders can exert power through three mechanisms. First, they can participate directly in the decision making process through the (proxy) votes attached to their investments. In a situation of dispersed and fragmented ownership, the voting power of each individual shareholder is rather limited. But blockholders with at least five percent of the shares are generally considered highly influential, and shareholders that hold more than 10 percent are already considered “insiders” to the firm under U.S. law. The growing equity positions that passive asset managers hold thus increase this potential power.”

“The size of a node in the visualization can be interpreted as the potential shareholder power of the particular owner within the network of control over listed companies in the United States. Thus, when seen together, the Big Three occupy a position of unrivaled potential power over corporate America.

They conclude:

When Vanguard pioneered its index fund concept in the mid-1970s it was attacked as “un-American,” exactly because they held shares in all the firms of an index and did not try to find the companies that would perform best. Therefore, the new tripartite governing board of BlackRock, Vanguard, and State Street is potentially conflicting with the image of America as a very liberal market economy, in which corporations compete vigorously, ownership is generally fragmented, and capital is generally seen as “impatient.” Benjamin Braun has argued that passive investors may, in principle, act as “patient” capital and thus facilitate long-term strategies. Hence, the Big Three have the potential to cause significant change to the political economy of the United States, including through influencing important topics for corporations, such as short-termism versus long-termism, the (in)adequacy of management remuneration, and mergers and acquisitions. We reflected on a number of anti-competitive effects that come with the rise of passive asset management, which could have negative consequences for economic growth and even for economic equality. As well, we signaled how the continuing growth of ETFs and other passive index funds can create new financial risk, including increased investor herding and greater volatility in times of severe financial instabilities.”

Strategy 2: Active Management-Factor Funds

Objective: The objective of factor funds, or multi factor funds, is to capture specific factors that academic research has shown to beat the overall market over long measurement periods.

Factor investors, like index investors, are simply trying to own the market, while capturing the factor premiums that research shows come from some variation of the Five Factor Model, for example. This model was introduced by Eugene Fama, and Kenneth French. Their research demonstrated that stocks beat bonds (market factor), value stocks beat growth stocks (value factor), small cap stocks beat large cap stocks (Size factor), profitable companies beat non profitable companies (profitability factor), and positive investment characteristics beat those with negative investment characteristics (investment factor).

Therefore, they argued, that by tilting towards these factors of outperformance, we would stand a better chance at beating the market in a more efficient systematic manner. Dimensional Fund Advisors (DFA), is the largest provider of dedicated, research based, factor strategies.

They have been able to beat the market at a higher rate than traditional active management, not through security selection but rather factor tilting. Using these funds, however, requires a DFA financial advisor, which will mean an increase in cost to the investor. However, factor funds are now offered by many different providers, both in single factor and multi factor strategies.

Best For: Investors who are seeking a low cost, academically-based strategy to beat the market through the capture of factor premia. These funds are quite passive in nature but are categorized as active because of the factor tilting strategy, which does create tracking error, which at times can be significant depending on the specific factor targeting strategy utilized. This strategy is not advised for investors who are not comfortable with tracking error.


  • While these funds are actively targeting specific factors, they are highly passive in nature.
  • They can be purchased at a relatively low cost in mutual fund and ETF form.
  • They provide exposure to specific factors which research demonstrates, may allow investors to outperform the market over the long run.


  • If factors go out of favor for extended periods, investors could underperform the broad index.
  • There is no telling that the future will look like the past, and thus targeting specific factors may become more challenging, or unreliable as markets, and economies change.
  • Some of these strategies require a financial advisor, which may increase the overall cost to the investor, and meaningfully drag down net investment results.


In this first piece, I took a look at passive investment strategies both through the broad index fund as well as the factor fund lens. In Part II, I will explore various forms of active management, and what investors would benefit most from each. Taken together, these two pieces should be read together, and can serve as a guide to choosing the right investment strategy for you.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is for informational purposes only and is not an offer to buy or sell any security. It is not intended to be financial advice, and it is not financial advice. Before acting on any information contained herein, be sure to consult your own financial advisor. This article does not constitute tax advice. Every investor should consult their tax advisor or CPA before acting on any information contained herein.

Women stressed over finances

DFA Advisors picks advisers and it works

Reposted from

With its data-driven models the company attracted third-most money in 2014 behind Vanguard and JPMorgan

Jan 19, 2015 @ 9:14 am

By Bloomberg News

When Molly Bernet Balunek expressed interest in putting money into mutual funds run by Dimensional Fund Advisors, she didn’t know she was in for a rigorous courtship ritual.

Before getting the go-ahead to invest in Dimensional’s products last year, Ms. Balunek, a financial adviser from Cleveland, had to submit to an interview, fill out a questionnaire and pay out of her own pocket for a two-day trip to Austin, Texas, where she listened to the company’s executives explain how they do business. The process, which Ms. Balunek described as “intense,” took about five months.

“It is a two-way evaluation process — Dimensional wanted to understand my business structure and investment philosophy as much as I wanted to understand theirs,” said Ms. Balunek.

The ritual is part of a sales process that has helped Dimensional attract the third-most money last year after Vanguard Group Inc., known for its low-cost index funds, and JPMorgan Chase & Co. Like Vanguard,

(More: Advisers’ favorite money managers)

Dimensional is capitalizing on a growing belief that stock pickers can’t consistently beat markets. Dimensional’s approach, though, comes with a twist: unlike traditional index strategies, the funds use data-driven models to beat traditional benchmarks.

Dimensional is among a small group of managers toppling the dominance of firms such as Fidelity Investments and Capital Group, which have built their reputations on picking individual stocks. Among the fastest-growing U.S. mutual fund firms after assets surged almost six-fold in the past decade, Dimensional attracted almost $28 billion in new money in 2014.

Dimensional believes beating the markets is an exercise in futility and most managers cannot justify the fees they charge. What sets Dimensional apart is its investment philosophy, using research pioneered by Nobel laureate Eugene Fama and Kenneth French, of focusing on specific factors or dimensions that have helped certain indexes beat benchmarks such as the S&P 500 Index.

Dimensional, which sells its funds only through approved advisers and never directly to the public, spends considerable effort educating investors on how its approach works. Its system of picking advisers breeds a high degree of loyalty. The firm received the highest grades in customer loyalty among mutual fund companies in a July 2014 survey of U.S. financial advisers conducted by Cogent Reports of Cambridge, Mass.


“They’ve developed a brilliant way of locking in money and the advisers who use them seem to love it,” said Lawrence Glazer, a managing partner at Mayflower Advisors, a Boston-based adviser that oversees $2 billion.

David Butler, who runs Dimensional’s financial adviser business, said he could “count on one hand,” the advisers who have stopped using the company’s funds in his nearly 20 years at the company.

Advisers who use Dimensional, “tend to buy into the firm’s unique philosophy and investment approach and direct a higher proportion of their mutual fund dollars to the firm,” Linda York, a Cogent vice president, wrote in an e-mail.

Dimensional’s assets have more than doubled since 2009 to $381 billion in a mix of mutual funds and institutional accounts. Part of the growth is the result of shifting client sentiment, as investors disillusioned with the ability of stock pickers to insulate them from losses during the 2008 crisis have increasingly turned to cheaper alternatives such as index mutual funds and exchange-traded funds.

Mutual funds that pick U.S. stocks experienced $98 billion in redemptions in 2014. During the same period, investors added $167 billion to domestic stock index funds and ETFs, according to data from Chicago-based Morningstar Inc.

Vanguard attracted $219 billion in mutual fund and ETF deposits last year. Fidelity had redemptions of $5.3 billion while American Funds, the mutual fund arm of Capital Group, won $345 million.

Mayflower’s Mr. Glazer said while low-cost indexing is popular at the moment, there is no guarantee it will remain so.

“If the history of asset management is any guide, the companies and styles that were the leaders in one decade, won’t be the leaders in the next decade.”


“Conventional active managers promised a lot that they weren’t able to deliver,” David Booth, 68, chairman and co-founder of Dimensional, said in an interview at his company’s headquarters in Austin.

Mr. Booth built his firm around the ideas of his University of Chicago mentor Mr. Fama, who won the 2013 Nobel Prize in economics for his work on efficient markets. In 2008, crediting the school for his success, Mr. Booth donated $300 million to his alma mater, which renamed its business school the University of Chicago Booth School of Business.

Mr. Fama and his research partner, Dartmouth College’s Mr. French, have argued that stock-price movements are unpredictable and that trying to pick securities that will beat the market is pointless.

“Most people are fooling themselves when they think they have the ability to hire a superior manager,” said Mr. French, in a video posted on Dimensional’s website.

The pair’s research also shows that certain factors can produce higher returns. Using historical market data, they found that over the long term, small stocks have outperformed large ones, value-oriented equities have beaten growth and more profitable companies have done better than less profitable peers. Dimensional’s funds reflect those tilts, with portfolios composed of small-cap companies, value shares and stocks of companies with above-average profits.

Over the past five, 10 and 15 years, Dimensional’s stock funds have outperformed about 70% of peers, according to Denver-based Lipper. Bond funds, a smaller piece of the business, trailed about 60%. Over the past 15 years, almost 90% of the company’s stock and bond strategies with a track record that long have topped their benchmarks, Dimensional data show.

Dimensional executives say that they can’t quantify or guarantee the amount of outperformance they can generate.

“If we can beat the benchmarks by 50 basis points a year — and in many strategies by 100 basis points — I will do handstands,” said Mr. Booth.

For the last 15 years, Dimensional’s funds have benefited from a rally in small-capitalization and value shares. Since the end of 1999, small stocks, as measured by the Russell 2000, have returned more than twice as much as large stocks, represented by the S&P 500 Index. Value stocks gained about four times as much as growth stocks.


The opposite pattern prevailed during the technology boom of the late 1990s, as big stocks and growth stocks outperformed, data compiled by Bloomberg show. In 2014, small cap stocks lagged behind large ones by a wide margin. They trailed again in 2015 through Jan. 13.

William Smead, a stock picker who runs the $952 million Smead Value Fund and invests in big companies, said if historical patterns hold, small cap stocks could lag behind large ones for the next six to nine years.

Setting realistic expectations for performance is just one piece of Dimensional’s close relationship with advisers, a relationship that began as an accident, according to Mr. Booth.

In the 1980s, the firm managed money exclusively for institutional investors. In 1988, an adviser approached Mr. Booth about investing in Dimensional funds.

The idea was intriguing and also somewhat disturbing, said Mr. Booth, who was concerned that advisers would move in and out of the funds too often, burdening other investors with higher costs. Minimizing trading costs is part of Dimensional’s plan for adding value. The solution was to create a system in which the company could pick advisers who bought into Dimensional’s approach and played by its rules.

“They don’t want advisers who are traders, they don’t want hot money and they don’t want people who are chasing performance,” said Ms. Balunek, who described the process of becoming a Dimensional adviser as more “invasive” than she anticipated.

Mr. Booth said the extended process — including having advisers pay their own way to the introductory seminar — has paid dividends.

“We have made it kind of a pain in the neck to buy the funds, but that has created a mutual affinity.”

Bob Rall, an adviser from Merritt Island, Fla., can speak to that affinity. He started out with a firm that tried to pick individual securities and said he got tired of client losses because of bad stock picks.

He found out about Dimensional 12 years ago and attended one of their conferences. Mr. Rall now has about 90% of the $35 million he oversees invested in Dimensional funds.

“They poured us big glasses of Kool-Aid, we drank it and haven’t looked back,” he said.

Advisers are also attracted to the credentials of the academics behind Dimensional’s investing and trading strategies. In addition to Mr. Fama and Mr. French, Nobel Prize winner Robert Merton of Massachusetts Institute of Technology is involved in designing products for the company.

Having advisers that believe in the firm creates another benefit for Dimensional and its customers, according to Michael Rosen, chief investment officer at Angeles Investment Advisors in Santa Monica, Calif., who oversees $45 billion for endowments and pensions.


“Educated advisers are more likely to prevent their clients from making radical changes when markets drop,” said Mr. Rosen. “The fact that those assets are sticky will add value for the investors.”

Dimensional’s approach to markets, with its tilts toward small and value stocks, at one time made it distinct in the money-management business, said Alex Bryan, an analyst with Morningstar. Many firms are now competing in the same arena including AQR Capital Management, he said, and products such as low-cost ETFs are also vying for investor capital.

“Investors have a lot of options now,” said Mr. Bryan. “They don’t have to go to Dimensional to get exposure to those strategies.”

Mr. Booth isn’t worried by the competition. He has invested in systems that will allow the firm to grow, although he refrains from projecting how big it might get. When the company passed $50 billion in assets in 2004, he said, “It was already bigger than we thought it could possibly be.”

Mr. Booth, who owns Dimensional along with other past and current employees and directors, doesn’t see that changing anytime soon. He said he has turned down repeated requests to sell Dimensional or take it public.

“The next generation of leadership is in place and they will worry about firm ownership,” said Mr. Booth. “For the time being we are ignoring the fact that we are getting older. This is what we want to be doing.”

award winning trophy shot in black background

DFA Named “Retirement Leader of the Year”

Award presented at 24th Mutual Fund Industry Awards in New York honors firm for developing innovative retirement solutions that positively impact the retirement marketplace


Dimensional Fund Advisors

25 Apr, 2017, 10:00 ET

AUSTIN, Texas, April 25, 2017 /PRNewswire/ — Dimensional Fund Advisors, a leading global investment management firm that has developed an innovative target date solution designed to reduce uncertainty around the consumption that a plan participant’s savings can support in retirement, is honored to be recognized as “2017 Retirement Leader of the Year” by Fund Intelligence, sponsor of the 24th Mutual Fund Industry Awards.

Presented during a ceremony at Cipriani 42nd Street® in New York City, the award is given to “a firm that has made a key impact on growing retirement assets with unique retirement solutions, marketing campaigns and significant contributions to the retirement industry at large,” according to Fund Intelligence. The judging period was from January 1, 2016, to December 31, 2016.

“We are honored to receive this kind of recognition,” said Eduardo Repetto, Dimensional’s Co-CEO and Co-Chief Investment Officer. “It represents years of dedicated research on life cycle solutions. We have worked closely with Nobel laureate Robert Merton, clients, advisors, consultants, and recordkeepers in order to provide transparent low-cost investment solutions as well as benchmarking and reporting tools designed specifically for participants saving for retirement.”

Dimensional is a well-established leader in the Defined Contribution (“DC”) arena with nearly $47 billion in dedicated DC assets as of December 31, 2016. The firm was also ranked ninth in the 2016 PLANADVISER Retirement Plan Adviser Survey of the top 20 fund families preferred by plan advisers.

Next Generation Retirement Solutions
The main challenge of retirement planning is managing the uncertainty of future income. Dimensional believes a smart income-focused solution should take into account the investment risks that affect retirement income, such as rising inflation and changes in interest rates.

Dimensional’s Target Date Retirement Income Funds are professionally managed mutual funds designed to offer a convenient, long-term solution for investors who expect to retire in or around a particular year. The Funds are diversified across a mix of asset classes that include stocks and bonds, and over time the investment emphasis of the Funds shifts from income growth to income risk management. This shift means more portfolio assets are invested in inflation-protected securities to manage future risks to retirement income.

“If we are going to have progress in the area of investing and finance, the innovation has to come from better and safer financial services,” said David Booth, Dimensional’s founder and Executive Chairman. “That’s what will lift us all up, and that’s exactly what we are trying to do with our retirement solutions. So it’s very gratifying to see our efforts celebrated.”

Measuring Effectiveness
To help measure effectiveness relative to an income-focused goal, Dimensional worked collaboratively with S&P Dow Jones Indices (S&P DJI) to develop the glide path, inflation hedging, and duration hedging techniques used in the S&P Shift To Retirement Income and DEcumulation (STRIDE) Index series, launched in January 2016. This is the first Index to blend the process of wealth creation with the need to mitigate uncertainty of in-retirement consumption. By considering both key retirement risks and post-retirement income needs for an individual in its methodology, the Index series seeks to provide an enhanced target date benchmark for strategies that follow a liability-driven investing philosophy.

About the 24th Annual Mutual Fund Industry Awards
The Mutual Fund Industry Awards recognize and reward the people and organizations whose excellence, achievements, and contributions to the industry have stood out over the past 12 months. Nominations are made by the editorial staff of industry publications Fund Action and Fund Direction, which are part of the Fund Intelligence Group, a provider of financial services sector information products. The 24th Mutual Fund Industry Awards were presented at an evening ceremony and dinner on March 30, 2017.

About Dimensional
Dimensional Fund Advisors is a leading global investment firm that has been translating academic research into practical investment solutions since 1981. Guided by a strong belief in markets, we help investors pursue higher expected returns through advanced portfolio design and careful implementation. With clients around the world, Dimensional has 12 offices in eight countries and global assets under management of $497 billion as of March 31, 2017. Learn more at

Retirement Thought Leadership:
Harvard Business Review: The Crisis in Retirement Planning, by Robert Merton
How Much Should I Save for Retirement, by Dimensional’s Massi De Santis and Marlena Lee

Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission. Consider the investment objectives, risks, and charges and expenses of the Dimensional funds carefully before investing. For this and other information about the Dimensional funds, please read the prospectus carefully before investing. Prospectuses are available by calling Dimensional Fund Advisors collect at (512) 306-7400 or at Dimensional funds are distributed by DFA Securities LLC.

Target date funds are designed to target a year in which an investor may withdraw funds for retirement or other purposes. Investments in target date funds are subject to the risks of their underlying funds, and asset allocations are subject to change over time in accordance with each fund’s prospectus. An investment in a retirement income from a target date portfolio is not guaranteed at any time, including on or after the target date. An investment in a target date portfolio does not eliminate the need for investors to decide –before investing and periodically thereafter–whether the portfolio fits their financial situation. For more information, please refer to the prospectus. There is no guarantee this investment strategy will be successful, and it is possible to lose money with this investment. For more information regarding Dimensional’s Target Date Retirement Income Funds, please refer to the prospectus.

Dimensional Fund Advisors LP receives compensation from S&P Dow Jones Indices in connection with licensing rights to S&P STRIDE Indices. Robert Merton provides consulting services to Dimensional Fund Advisors LP.


SOURCE Dimensional Fund Advisors

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Tim Maurer

The Three-Step Investor’s Guide

Reposted from

Personal finance is more personal than it is finance.  Opinions expressed by Forbes Contributors are their own.

As an educator in the arena of personal finance, I generally avoid matters of public policy or politics because they tend to devolve into dogma and division, all too often leaving wisdom and understanding behind. But occasionally, an issue arises of such importance that I feel an obligation to advocate on behalf of those who don’t have a voice. The issue of the day revolves around a single word: “fiduciary.”

At stake is a Department of Labor ruling set to take effect this coming April that would require any financial advisor, stock broker or insurance agent directing a client’s retirement account to act in the best interest of that client. In other words, the rule would require such advisors to act as a fiduciary. The incoming Trump administration has hit the pause button on that rule, a move that many feel is merely a precursor to the rule’s demise.

Why? Because a vocal constituency of the new administration has lobbied for it—hard. They stand to lose billions—with a “b”—so they’re protecting their profitable turf with every means necessary, even twisted logic.

The good news is that informed investors need not rely on any legislation to ensure they are receiving a fiduciary level of service. Follow these three steps to receive the level of service you deserve:

1) Ask your advisor if he or she acts as a fiduciary.

It’s not a good sign if you get the deer-in-headlights look followed by “Fid-oo-she-WHAT?” If your advisor gets defensive, telling you that you’re better off with the status quo, that’s also concerning.

2) Ask your advisor if he or she acts ONLY as a fiduciary.

One of the biggest challenges facing investors today is that many advisors with a genuine fiduciary label are actually part-time fiduciaries. This is where it gets tricky, because there are at least three different regulatory requirements in the financial industry.

Those beholden to the Investment Advisers Act of 1940 and regulated by the SEC are fiduciaries already, and they have been for a long time. Those who sell securities—typically known as stock brokers and regulated by FINRA—are held to a lesser “suitability” standard. Those who sell insurance products may be beholden to an even lesser standard—caveat emptor, or “buyer beware.”

But what if your advisor is like many who are licensed sufficiently that they may act as a fiduciary when they choose, but may also take off the advisory hat and sell you something as a broker or agent? Do they tell you when they’ve gone from one to the other?

You want a full-time, one-hat-wearing fiduciary.

3) Determine if your advisor is a TRUE fiduciary.

This may be the hardest part, because it requires you to read between the lines. There are advisors who now realize that it’s simply good business to be a fiduciary. And while there’s nothing wrong with profitable business, you don’t want to work with someone just because they’ve realized fiduciary mousetraps sell better than their rusty predecessors.

Not everyone who is a fiduciary from a legal or regulatory perspective is a fiduciary at heart, and yes, it is also true that there are those who are fiduciaries at their core even though they don’t meet the official definition in their business dealings.

You want a practitioner who’s a fiduciary through-and-through—a fiduciary in spirit and in word.

“The annulment of the government’s fiduciary rule would clearly be a setback for investors trying to prepare for retirement,” says sainted financial industry agitate Jack Bogle. “But the fiduciary principle itself will live on, and even spread.”

Yes, the good news—for both advisors and investors—is that there is a strong and growing community of fiduciaries, supported by the Certified Financial Planner™ Board, the Financial Planning Association (FPA) and the National Association of Personal Financial Advisors (NAPFA).

Advisors can join the movement. And investors can insist on only working with a true, full-time fiduciary.

I’m a speaker, author of “Simple Money” and director of personal finance for Buckingham and the BAM Alliance. Connect with me on Twitter, Google+, and click HERE to receive my weekly email.

Larry Swedro

Lessons from 2016

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Every year, the market provides us with some important lessons on prudent investment strategy. Many times, the market will offer investors remedial courses, covering lessons that it has already delivered in previous years. That’s why one of my favorite sayings is that there’s nothing new in investing—there’s only investment history you don’t yet know.

Last year gave us nine lessons. As you may note, many of them have appeared before. Unfortunately, many investors fail to learn from them. Rather, they keep repeating the same errors, which is what Albert Einstein called the definition of insanity. We’ll begin with my personal favorite, a lesson the market, if measured properly, teaches each and every year.

Lesson 1: Active Management Is a Loser’s Game

Despite an overwhelming amount of research that demonstrates passive investing is far more likely to allow you to achieve your financial goals, the vast majority of individual investor assets are still invested in active funds. And, unfortunately, investors in active funds continue to pay for their “triumph of hope over wisdom and experience.”

2016 was another year where the large majority of active funds underperformed, despite the great opportunity for active managers to generate alpha in the very large dispersion of returns between the best and worst performers.

For example, while the S&P 500 returned 12.0% for the year, there were 25 stocks in the index that returned at least 45.5%. Oneck Inc. (OKE) returned 132.8%, while Nvidia Corp. (NVDA) returned 223.9%. All an active manager had to do to outperform was to overweight these superperformers.

On the other side of the coin, there were 25 stocks in the index that lost at least 22.9%. Endo International (ENDP) lost 73.1% and First Solar (FSLR) lost 51.4%. To outperform, all an active manager had to do was to underweight, let alone avoid, these “dogs.”

It’s important to note that this wide dispersion of returns is not at all unusual. Yet despite the opportunity, year after year, in aggregate, active managers persistently fail to outperform. The table below shows the percentile rankings for funds from two leading providers of passively managed funds, Dimensional Fund Advisors (DFA) and Vanguard, for both 2016 and the 15-year period ending December 2016. (Full disclosure: My firm, Buckingham, recommends DFA funds in constructing client portfolios.)

Note that Morningstar’s data contains survivorship bias, as it only considers funds that have survived the full period. And the bias is significant, as about 7% of actively managed funds disappear every year and their returns are buried in the mutual fund graveyard. Thus, the longer the period, the worse the survivorship bias, and at 15 years, it’s quite large.

The results make clear that active management is a strategy we could call fraught with opportunity. Year after year, active managers come up with an excuse to explain why they failed that year and then assert that next year will be different. Of course, it never is.

The good news is that investors are waking up to the reality. In October, The Wall Street Journal reported that, according to Morningstar, “although 66% of mutual-fund and exchange-traded-fund assets are still actively invested … those numbers are down from 84% 10 years ago and are shrinking fast.”

Lesson 2: So Much of Returns Come in Very Short and Unpredictable Bursts

The road to investment “hell” is paved with market-timing efforts, because so much of the long-term returns provided by the market come in short, and totally unpredictable, bursts. Last year provided the following example. From January through October, the DFA Small Value Fund (DFSVX) returned 8.0%. From November through December, it returned 18.8%. For the full year, it returned 28.3%. Two-thirds of the full year’s return happened in the last two months.

These types of results are not at all unusual, For instance, the study “Black Swans and Market Timing: How Not To Generate Alpha,” which covered the 107-year period ending in 2006, found that the best 100 days (out of more than 29,000) accounted for virtually all (99.7%) of returns.

Here’s another example. There are 1,020 months in the 85-year period from 1926 through 2010. The best 85 months, an average of just one month a year (or just 8.3% of the months), provided an average return of 10.7%. The remaining 935 months (or 91.7% of the months) produced virtually no return (just 0.05%).

Peter Lynch offered the following example. He pointed out that an investor who followed a passive investment strategy and stayed fully invested in the S&P 500 over the 40-year period beginning in 1954 would have achieved an 11.4% rate of return.

If that investor missed just the best 10 months (2%), his return dropped 27%, to 8.3%. If the investor missed the best 20 months (4%), the return dropped 54%, to 6.1%. Finally, if the investor missed the best 40 months (8%), the return dropped 76%, all the way to 2.7%.

Do you really believe there is anyone who can pick the best 40 months in a 40-year period? Lynch put it this way: “Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves.”

Despite this evidence, investors persist in market-timing efforts. Charles Ellis described the winning strategy in the following way: “Investors would do well to learn from deer hunters and fishermen who know the importance of ‘being there’ and using patient persistence—so they are there when opportunity knocks.”

Lesson 3: Events Occur That No One Predicted

Those who have spent their careers forecasting learn to be very humble about their predictions. The reason is that almost every year, major surprises occur. And by definition, surprises are unpredictable.

That is why, when I’m asked for a forecast, my response is that my crystal ball is always cloudy. That is also why my recommendation is to stop spending time listening to forecasts, which have no value and can cause you to stray from your well-thought-out plan. Instead, spend your time managing risk.

2016 saw at least two major unpredicted events that could have had major negative impacts on financial markets. Yet they did not. The first came in June when Great Britain voted for exiting the European Union—the so-called Brexit, which passed 52% to 48% with a referendum turnout of 72% and votes from more than 30 million people.

The other, of course, was the primary win by Donald Trump and then his election to the presidency. With both Brexit’s and Trump’s victories, the market’s immediate reaction was a dramatic self-off. And then a rapid recovery.

Lesson 4: Ignore All Forecasts; All Crystal Balls Are Cloudy

One of my favorite sayings about the market forecasts of so-called experts is from Jason Zweig, financial columnist for The Wall Street Journal: “Whenever some analyst seems to know what he’s talking about, remember that pigs will fly before he’ll ever release a full list of his past forecasts, including the bloopers.”

You’ll almost never read or hear a review of how the latest forecast from some market “guru” actually worked out. The reason is that accountability would ruin the game—you would cease to “tune in.”

But I believe forecasters should be held accountable. Thus, a favorite pastime of mine is keeping a collection of economic and market forecasts made by media-anointed gurus and then checking back periodically to see if they came to pass. This practice has taught me there are no expert economic and market forecasters.

Here’s a small sample from this year’s collection. I hope they teach you a lesson about ignoring all forecasts, including the ones that happen to agree with your own notions (that’s the deadly condition known as “confirmation bias” at work).

  • In July 2015, Charles Robertson, Renaissance Capital’s global chief economist, predicted that U.S. stocks could crash 50% within the next 12 months.
  • In January 2016, economists at the Royal Bank of Scotland warned that investors faced a “cataclysmic year” in which stock markets could fall by up to 20% and oil could drop to $16 a barrel. The advice was to “sell everything” except safe bonds.
  • In May 2016, legendary investor Carl Icahn warned that “a day of reckoning” was coming for U.S. stock markets unless the federal government stimulated the economy with greater spending. He certainly was putting his money where his mouth was, as shortly before his prediction of a big crash, Icahn Enterprises had announced in SEC filings that it had a net short position of 149%.
  • Also in May 2016, Savita Subramanian, Bank of America Merrill Lynch’s head of U.S. equity and quantitative strategy, appeared on BloombergTV to warn of a “vortex of negative headlines” (doesn’t that sound scary?) coming in the following month that could push the S&P 500 down to 1,850 (a level back near its February lows). The factors she cited to support this prediction were the then-upcoming Brexit vote, the June decision from the Federal Reserve and the U.S. election.
  • Again in May 2016, John Hussman of Hussman Funds wrote: “Prevailing market conditions continue to hold the expected stock market return/risk profile in the most negative classification we identify. That profile reflects not only extreme valuations on the most reliable measures we’ve tested across history, but market internals and other features of market action that remain unfavorable. …. In any event, looking beyond the near-term horizon, I doubt that any shift in market action will meaningfully reduce the likelihood of a 40-55% loss in the S&P 500 over the completion of the current market cycle.”
  • In August 2016, UBS warned of an imminent crash in the S&P 500. The bank predicted there would be a major correction within the next two months.

As poor as the preceding forecasts turned out to be, this one is my personal favorite: Just six weeks into 2016, Goldman Sachs announced that (whoops!) it had abandoned five of its six recommended “top trade” calls for the year, having gotten them wrong.

One might ask: If they got those wrong, why ever would we think they’ll get it right this time? Of course, Goldman Sachs was just as confident of its new trade calls as it was when it made its old forecasts. Overconfidence is an all-too-human trait.

To be fair, there were surely some forecasts that turned out right. The problem is that you can’t know ahead of time which ones to pay attention to and which ones to ignore. What my experience has taught me is that investors tend to pay attention to the forecasts that agree with their preconceived ideas (again, that pesky confirmation bias) while ignoring forecasts that disagree. Being aware of our biases can help us overcome them.

Lesson 5: Even With A Clear Crystal Ball …

Imagine you had a crystal ball that allowed you to foresee the economic and political events of 2016, but not stock prices. Surely that would be of great value in terms of investment decisions—or would it have been?

Would you have been a buyer of stocks if you knew that the first few weeks of 2016 would produce the worst start to a year since the Great Depression? The S&P 500 Index closed 2015 at 2,043. By Jan. 20, it had fallen to 1,859, a drop of just more than 9%.

Would you have been a buyer of stocks knowing that Great Britain would vote to exit the European Union, creating great uncertainty for the global economy and financial markets? Within three days, the S&P 500 Index fell from 2,113 at the close on June 23 to 2,001 on June 27, a drop of more than 5%.

Would you have been a buyer of stocks if you knew that, once again, the economic growth rate would disappoint, with growth failing to reach even a tepid 2%? Most of the world’s developed economies were basically stagnating, bordering on recession.

Finally, would you have been a buyer of stocks knowing that Donald Trump would win the presidential election? Be honest now, especially if you happen to lean Democrat. Within moments of his victory becoming clear, the DJIA fell more than 800 points and S&P futures had sunk more than 5%.

With the benefit of hindsight, we now know that, in each instance, the market recovered, and relatively quickly. The lesson here is that, even with a clear crystal ball (which no one has), it’s very difficult to predict stock markets. Thus, you shouldn’t try. It’s a loser’s game.

Lesson 6: Last Year’s Winners Are Just As Likely To Be This Year’s Dogs

The historical evidence demonstrates that individual investors are performance-chasers—they watch yesterday’s winners, then buy them (after the great performance), and watch yesterday’s losers, then sell them (after the loss has already been incurred).

This causes investors to buy high and sell low, which is not exactly a recipe for investment success. This behavior explains the findings from studies showing that investors actually underperform the very mutual funds in which they invest.

Unfortunately, a good (poor) return in one year doesn’t predict a good (poor) return the next year. In fact, great returns lower future expected returns, and below-average returns raise future expected returns. Thus, the prudent strategy for investors is to act like a postage stamp. The lowly postage stamp does only one thing, but it does it exceedingly well: It adheres to its letter until it reaches its destination.

Similarly, investors should adhere to their investment plan (asset allocation). Sticking with one’s plan doesn’t mean just buying and holding. It actually means buying, holding and rebalancing (the process of restoring your portfolio’s asset allocation to your investment plan’s targeted levels).

Using passive asset class funds from Dimensional Fund Advisors (DFA), the following table compares the returns of various asset classes in 2015 and 2016. (Full disclosure: My firm, Buckingham, recommends DFA funds in constructing client portfolios.) As you can see, sometimes the winners and losers of 2015 repeated their respective performances, but other times the winners became losers and the losers became winners. For example:

Lesson 7: “Sell in May and Go Away” Is the Financial Equivalent of Astrology

One of the more persistent investment myths is that the winning strategy is to sell stocks in May and wait to buy back into the market until November.

While it’s true that stocks have provided greater returns from November through April than they have from May through October, since 1926, an equity risk premium has still existed in those May-through-October months. From 1927 through 2015, the “Sell in May” strategy returned 8.3% per year, underperforming the S&P 500 by 1.7 percentage points per year. And that’s even before considering any transaction costs, let alone the impact of taxes (with the “Sell in May” strategy, you’d be converting what would otherwise be long-term capital gains into short-term capital gains, which are taxed at the same rate as ordinary income).

How did the “Sell in May and Go Away” strategy work in 2016? The S&P 500 Index’s total return for the period from May through October was 4.1%. Alternatively, during this same period safe, liquid investments would have produced virtually no return. In case you’re wondering, 2011 was the only year in the last eight when the “Sell in May” strategy would have worked.

A basic tenet of finance is that there’s a positive relationship between risk and expected return. To believe that stocks should produce lower returns than Treasury bills from May through October, you have to believe stocks are less risky during those months—a nonsensical argument. Unfortunately, as with many myths, this one seems hard to kill off. And you can bet that, next May, the financial media will be resurrecting it once again.

Lesson 8: Hedge Funds Are Not Investment Vehicles, They Are Compensation Schemes

This lesson has appeared about as regularly as our first lesson, which is that active management is a loser’s game. Hedge funds entered 2016 coming off their seventh-straight year of trailing U.S. stocks (as measured by the S&P 500 Index) by significant margins.

Unfortunately, the streak has continued into an eighth year, as the HFRX Global Hedge Fund Index returned just 2.5% in 2016, and underperformed the S&P 500 Index by 9.5 percentage points. The table below shows the returns for various equity and fixed income indexes.

As you can see, the hedge fund index underperformed the S&P 500 and eight of the 10 major equity asset classes, but managed to outperform all three of the bond indexes. An all-equity portfolio allocated 50% internationally and 50% domestically, and equally weighted in the asset classes within those broad categories, would have returned 11.0%, outperforming the HFRX index by 8.5 percentage points. A 60% equity and 40% bond portfolio with the same weights for the equity allocation would have returned 6.9% using one-year Treasurys, 7.6% using five-year Treasurys and 7.1% using long-term Treasurys.

Thus, each of these three portfolios would have outperformed the hedge fund index. Given that hedge funds tout their freedom to move across asset classes as their big advantage, one would think that it would have shown up. The problem is that the efficiency of the market, as well as the costs of the effort, turns that supposed advantage into a handicap.

The evidence is even worse over the long term. For the 10-year period from 2007 through 2016, the HFRX Global Hedge Fund Index lost 0.6% per year, underperforming every single equity and bond asset class. As you can see in the following table, hedge fund underperformance ranged from 0.4 percentage points when compared to the MSCI EAFE Value Index, to as much as 8.8 ercentage points when compared to U.S small-cap stocks.

Perhaps even more shocking is that, over this period, the only year the hedge fund index outperformed the S&P 500 was in 2008. Even worse, when compared to a balanced portfolio allocated 60% to the S&P 500 Index and 40% to the Barclays Government/Credit Bond Index, it underperformed every single year.

For the 10-year period, an all-equity portfolio allocated 50% internationally and 50% domestically, again equally weighted in the asset classes within those broad categories, would have returned 4.1% per year. A 60% equity and 40% bond portfolio with the same weights for the equity allocation would have returned 3.0% per year using one-year Treasurys, 4.1% per year using five-year Treasurys and 5.1% per year using long-term Treasurys. All three dramatically outperformed the hedge fund index.

The bottom line is that the evidence suggests investors are best served by thinking of hedge funds as compensation schemes, not investment vehicles

Lesson 9: Don’t Let Your Political Views Influence Your Investment Decisions

One of my more important roles as director of research for Buckingham Strategic Wealth is preventing investors from committing what I refer to as “portfolio suicide”—panicked selling that arises from fear, whatever the source of that fear may be. After the election of President Donald Trump, it seemed like the vast majority of times I was called in to help investors stay disciplined and adhere to their financial plans involved anxiety generated by politics.

We often make investment mistakes because we are unaware that our decisions are being influenced by our beliefs and biases. The first step to eliminating, or at least minimizing, errors is to become aware of how our choices are impacted by our views, and how those views can influence outcomes.

The 2012 study “Political Climate, Optimism, and Investment Decisions” showed that people’s optimism toward both the financial markets and the economy is dynamically influenced by their political affiliation and the existing political climate. Among the authors’ findings were:

  • Individuals become more optimistic and perceive the markets to be less risky and more undervalued when their own party is in power. This leads them to take on more risk, and they overweight riskier stocks. They also trade less frequently. That’s a good thing, because the evidence demonstrates that the more individuals trade, the worse that they tend to do.
  • When the opposite party is in power, individuals’ perceived uncertainty levels increase and investors exhibit stronger behavioral biases, leading to poor investment decisions.

Now, imagine the nervous investor who sold equities based on his views about, or expectations for, a Trump presidency. While those who stayed disciplined have benefited from the rally following the election, investors who panicked and sold not only missed the bull market, but now face the incredibly difficult task of figuring out when it will be once again safe to invest.

I know of many investors with Republican/conservative leanings who were underinvested after President Obama was elected. And now it’s investors with Democratic/liberal leanings who have to face their fears. The December Spectrem Affluent Investor and Millionaire Confidence Index surveys provide evidence of how political biases can impact investment decisions.

Prior to the election, respondents who identified as Democrats showed higher confidence levels than respondents who identified as Republicans or Independents. This completely flipped after the election. Democrat investors registered a confidence reading of -10, while Republican and Independent investors showed confidence readings of +9 and +15, respectively.

What’s important to understand is that if you lose confidence in your plan and sell, there’s never a green flag that will tell you when it’s safe to get back in. Thus, the strategy most likely to allow you to achieve your financial goals is to have a plan that anticipates there will be problems, and to not take more risk than you have the ability, willingness and need to assume. Furthermore, don’t pay attention to the news if doing so will cause your political beliefs to influence your investment decisions.

In conclusion, this year will surely provide investors with more lessons, many of which will be remedial courses. And the market will provide you with opportunities to make investment mistakes. You can avoid them by knowing your financial history and having a well-thought-out plan.

This commentary originally appeared January 27 on

Larry Swedroe is the Director of Research for Buckingham Strategic Wealth. He has authored or co-authored more than a dozen books and is regularly published on and Advisor Perspectives. He has made appearances on national television shows airing on NBC, CNBC, CNN and Bloomberg Personal Finance. Larry holds an MBA in finance and investment from New York University, and a bachelor’s degree in finance from Baruch College in New York.


A Vote For Small Cap Stocks?

Re-posted from Dimensional – Weston Wellington, Down to the Wire

In the days immediately following the recent US presidential election, US small company stocks experienced higher returns than US large company stocks. This example helps illustrate how the dimensions of expected returns can appear quickly, unpredictably, and with large magnitude.

Average returns for US small company stocks historically have been higher than the average returns for US large company stocks. But those returns include long periods of both strong and weak relative performance.

Investors may attempt to enhance returns by increasing their exposure to small company stocks at what appear to be the most opportune times. Yet this effort to time the size premium can be frustrating because the most rewarding results often occur in an unpredictable manner.

A recent paper1 by Wei Dai, PhD, explores the challenges of attempting to time the size, value, and profitability premiums.2 Here we will keep the discussion to a simpler example.

As of October 31, 2016, small company stocks had outpaced large company stocks for the year-to-date by 0.34 percentage points.


To the surprise of many market observers, the broad stock market rose following the US presidential election on November 8, with small company stocks outperforming the market as a whole. In the eight trading days following the US presidential election, the small cap premium, as measured by the return difference between the Russell 2000 and Russell 1000, was 7.8 percentage points. This helped small company stocks pull ahead of large company stocks year-to-date, as of November 30, by approximately 8 percentage points and for a full one-year period by approximately 4 percentage points.


This recent example highlights the importance of staying disciplined. The premiums associated with the size, value, and profitability dimensions of expected returns may show up quickly and with large magnitude. There is no guarantee that the size premium will be positive over any period, but investors put the odds of achieving augmented returns in their favor by maintaining constant exposure to the dimensions of higher expected returns.

In the recent period following the US presidential election, US small company stocks experienced higher returns than US large company stocks. This column looks at these returns relative the historical small cap premium and discusses the importance maintaining constant exposure to the dimensions of higher expected returns.

1. Wei Dai, “Premium Timing with Valuation Ratios” (white paper, Dimensional Fund Advisors, September 2016).
2. Size premium: the return difference between small capitalization stocks and large capitalization stocks. Value premium: the return difference between stocks with low relative prices (value) and stocks with high relative prices (growth). Profitability premium: The return difference between stocks of companies with high profitability over those with low profitability.

Dimensional Fund Advisors LP (“Dimensional”) is an investment advisor registered with the Securities and Exchange Commission.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This content is provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.



DFA’s Disciplined Approach Earns It a Top Mark

Reprinted by permission of Morningstar, Oct. 26, 2016 • PM270965

The firm puts theory into practice with a focus on investors.

Fund Spy | 06-09-15 | by Alex Bryan

Morningstar recently issued a new Stewardship Grade for DFA. The
firm’s overall grade–which considers corporate culture, fund board
quality, fund manager incentives, fees, and regulatory history–is an A.
What follows is Morningstar’s analysis of the firm’s corporate culture,
for which DFA receives an A. This text, as well as analytical text on
the other four Stewardship Grade criteria, is available to subscribers
of Morningstar’s software for advisors and institutions: Morningstar
Advisor Workstation(SM), Morningstar Office(SM), and Morningstar

Dimensional Fund Advisors has forged a strong and distinctive culture
that has served investors well. The firm’s low-cost structure and
disciplined approach to investing, launching new strategies, and
qualifying the financial advisors who use its funds help set it apart. It
reflects a consistent, industry-leading focus on fundholders, and thus, we
are raising its Corporate Culture grade to an A from a B.

Dimensional’s investment philosophy is based on the idea that market
prices reflect all publicly available information–commonly known as
market efficiency. Therefore, it is not in the business of forecasting and
individual security selection. But that does not consign it to a broad
market-cap-weighted approach. The firm offers strategies that attempt
to beat the market by targeting exposures to what it views as the types
of risks that the market compensates. These are characteristics that
historically have been associated with higher expected returns, such as
credit, duration, value, small market capitalization, and profitability.
Each strategy the firm adopts must be economically sound and backed
by substantial empirical evidence that it has consistently delivered
attractive returns across different markets and time periods. DFA draws
heavily on academic research to develop its strategies. For example,
it maintains consulting relationships with several finance professors,
including two Nobel laureates, to stay on the cutting edge of financial
research. To bridge the gap between theory and implementation, DFA
maintains an in-house research team, which focuses on vetting and
applying academic research, testing new ideas, and improving the
implementation of its existing strategies.

Academic research has guided the evolution of DFA’s funds throughout
its history. DFA started out specializing in small-cap and micro-cap
funds, based on research suggesting that small-cap stocks outperform
their larger-cap counterparts. The firm launched its first value strategies
in 1993, a year after professors Eugene Fama and Kenneth French
published their seminal three-factor asset-pricing model, which indicated
that value stocks offer an additional return premium. Most recently, the
firm has incorporated a profitability tilt into its equity funds, based on
new research suggesting that profitability can help predict long-term
returns. These changes refined the strategies but did not fundamentally
alter them. This research paved the way for DFA to launch its first growth
funds, which target stocks with strong profitability.

Transaction-cost management is an essential tenet of DFA’s value
proposition. It avoids high-turnover strategies and incorporates
transaction costs into its portfolio construction framework. Because its
funds do not track an index, DFA’s managers are not forced to trade
when doing so would not be cost-effective. For example, if a security
is near the cusp of a fund’s targeted style zone but trading it would
significantly move prices against the fund, the fund may defer or avoid
trading it. The firm’s traders are rarely required to trade any specific
stock. They can substitute one stock for another that would be cheaper
to trade as long as it has the desired characteristics for the strategy.

DFA often leverages this flexibility to provide liquidity–responding to sell
orders with purchase orders or selling stocks to satisfy investor demand.
This flexibility distinguishes the firm and should help reduce transaction
costs. To further reduce costs and retain full control of its orders, DFA
has adopted an automated direct-market-access trading model, which it
now uses to place nearly all of its stock trades. As of March 2015, DFA
employed 23 traders with an average of 14 years of experience.

An investment committee meets twice a month to provide oversight for
the strategies and approve implementation changes. The committee
includes the firm’s senior executives and portfolio managers. DFA also
has a separate investment policy committee that meets to recommend
new strategies and enhancements to its existing strategies. Professors Fama and French sit on that committee, in a consultancy role, along with many of the firm’s senior executives.

While it has a large lineup of funds, DFA only targets a handful of drivers
of expected return. There is substantial overlap among its portfolios,
which gives investors the option to choose from funds with moderate
to more-exaggerated style tilts, but it also creates some redundancy in
the lineup. This overlap is a result of the firm’s willingness to adapt its
strategies to meet client demand. For example, it introduced a series
of core equity funds in response to client demand for a broad-market
portfolio with systematic small-cap and value tilts. It also offers some
socially responsible versions of its funds.

However, client whims don’t sway DFA from its methodical approach
to launching new strategies. It requires a heavy burden of supporting
empirical evidence before it will consider adopting a new strategy.
Even when the evidence is solid, the strategy must be consistent with
the firm’s low-turnover philosophy. For instance, despite the strong
empirical evidence that shows the near-term persistence of stock-price
momentum, DFA does not attempt to trade on it, though it may use
momentum as a reason to delay a trade. Although it has launched 22
funds during the past five years, most of these target the same sources
of expected return as its longer-standing funds.

Dimensional usually doesn’t chase trendy investment themes. Rather, it
takes its cues from the academic community. For example, the firm didn’t
abandon its stoic value framework during the tech boom in the 1990s.
Similarly, it hasn’t rushed to offer a low-volatility strategy because it
believes investors can achieve the same results more efficiently by
allocating a greater portion of their portfolios to fixed income and value
equity funds. As a result of its deliberate approach to its fund lineup,
DFA rarely liquidates or merges funds. In the United States, DFA has
merged or liquidated just three funds, according to Morningstar data. As
of March 2015, equity funds represented about 74% of the firm’s assets,
while fixed-income funds accounted for most of the remainder.

DFA has grown substantively during the past decade, now ranking
among the top 10 mutual fund companies with more than 6 times the
assets it had 10 years ago. It was able to accomplish that feat without
traditional advertising. Rather, it devotes considerable resources to
investor education, which is a major area of focus for the marketing

Unlike most mutual fund shops, Dimensional does not make its funds
available directly to individual investors. Instead, the funds are only available through an intermediary, such as a 401(k) platform, or a financial advisor that DFA has approved. Before qualifying advisors
to use its funds, Dimensional educates candidates on its investment
approach and attempts to filter out those who are likely to hold the funds
for the short term, a practice that could harm the strategies’ long-term
investors. The firm does not compensate or receive compensation
from advisors who use its funds. Investments from financial advisors
represent about 55% of Dimensional’s assets, while the remaining 45%
comes from institutional clients.

The firm’s client-education effort appears to be effective. In 2008, when
investors were leaving equity funds in droves, DFA bucked the trend
and enjoyed net inflows to its equity funds. But even this responsible
approach to selling has its limits. Like many fund families’, DFA’s dollarweighted
investor returns, which approximate how average investors
have done in individual funds, are generally subpar to its time-weighted
total returns over the past five and 10 years through April 2015.
Because DFA’s funds are so process-driven and its approach is
team-oriented, it may seem that portfolio-manager retention would be
less important than at other firms, where a star manager’s departure
would have a meaningful, detrimental impact. But manager retention is
still important because it is indicative of the firm’s ability to attract and
retain talent. Dimensional hires many of its portfolio managers straight
out of MBA programs. But the team has no shortage of seasoned
professionals. As of March 2015, the 45 members of the portfolio
management team had an average of 14 years of experience.

During the past five years, Dimensional has retained close to 92%
of its managers, which is strong compared with large mutual fund
companies. However, this figure is only based on the senior portfolio
managers that DFA lists in its regulatory filings with the Securities and
Exchange Commission. Dimensional has provided additional information
to Morningstar that indicates the retention rate for the broader portfolio
management team was above 90% in each year since 2009. This
suggests that its managers are well-suited to the firm’s distinctive
investment approach. The firm’s private ownership structure may also
contribute to its low turnover. Current and former employees own most
of the firm.

Alex Bryan, CFA, is director of passive strategies research,
North America for Morningstar.

Reprinted by permission of Morningstar, Oct. 26, 2016 • PM270965
Fund Spy | 06-09-15 | by Alex Bryan

Morningstar produces Stewardship Grades for asset management firms
and Stewardship Reports on the US fund industry’s 20 largest firms by
assets, which together manage more than two-thirds of open-end mutual
fund assets.

For those assigned a Stewardship Grade, Morningstar publishes letter
grades—A, B, C, D, or F—for each of the five components as well
as an overall letter grade. For firms that are assigned a Parent rating,
Morningstar gives them a Positive, Neutral, or Negative overall rating.
There is a direct relationship between a firm’s Stewardship Grade and its
Parent rating; firms with a Stewardship Grade of A or B receive a Positive
Parent rating, those with a C receive a Neutral Parent rating, and those
with a D or F receive a Negative Parent rating. The grades are based on
analyses by Morningstar’s fund researchers, Morningstar’s proprietary
data, and information compiled from public regulatory filings.

Morningstar analysts evaluate and assign grades from A (the best grade)
to F (the worst grade) to each of these areas, and they combine the
component grades to arrive at an overall Stewardship Grade for a family
of funds. A local committee of Morningstar fund analysts, which actively
studies industry stewardship practices in its market and beyond, reviews
the grades to ensure that the methodology is fairly and consistently
implemented. All fund firms are graded on an absolute basis.

Past performance is no guarantee of future results. There is no guarantee
strategies will be successful. Mutual fund investment risks include loss of
principal and fluctuating value. Small cap securities are subject to greater
volatility than those in other asset categories. Fixed income securities
are subject to increased loss of principal during periods of rising interest
rates. Fixed income investments are subject to various other risks,
including changes in credit quality, liquidity, prepayments, and other

Eugene Fama and Ken French are members of the Board of Directors
for and provide consulting services to Dimensional Fund Advisors LP.

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Dimensional funds are distributed by DFA Securities LLC.

October 24, 2016
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