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9 Reasons Investors Love Vanguard & DFA Funds

*** June 2015 article with information worth repeating***

Reposted from pathwayplanning.com

Wow. Vanguard had tremendous growth in 2014. An intake of $214.5 billion last year pushed this fund giant’s total assets to $3.1 trillion as of December 31, 2014. That growth represents a 56% increase for Vanguard compared to 2013. Early this year, they passed State Street Global Advisors as the second-largest exchange-traded fund provider as they close in on the top dog BlackRock.

Dimensional Fund Advisors (Dimensional or DFA funds for short) is another fund company that has been experiencing strong inflows. DFA funds added nearly $28 billion in assets in 2014, which was the third highest dollar amount of inflows last year, trailing only Vanguard and JPMorgan Chase.

That type of growth is doubly impressive because Dimensional Fund Advisors flies under the radar of many investors. Last year’s growth, however (not to mention a relatively steady inflow of assets since its 1981 founding), makes it clear that investors are attracted to DFA. What explains its rising-rock-star appeal, given its (yawn) nerdy tagline, “putting financial science to work”? Maybe it’s the firm’s laser-like focus and steadfast approach to applying academic research into the factors or “dimensions” that are expected to generate long-term wealth – fads and fashions be damned. For this blogger, anyway, it’s hard not to prefer that level of discipline to the usual frenzy involved in active stock picking and reactionary market timing.

Then again, Vanguard’s index and exchange-traded funds are no flashes in the pan either, also built on an investment strategy of substance. Admittedly, it can be confusing at a glance to understand how these two similar, but different fund companies compare. Let’s take a closer look at nine characteristics that help differentiate them from the crowd … and from each other.

 

Reason 1

Both trust the market knows best.

Yes, we are all brilliant, of course. However, when you consider that in 2014 alone there were some 60 million daily worldwide trades representing more than $300 billion dollars, it may be wise to embrace market pricing instead of trying to outguess the market. Vast, real-time, electronic information makes the market a highly effective price-setting machine. Trying to consistently outguess 60 million of your fellow investors is not unlike expecting to find enough single needles to outweigh an entire haystack, and to succeed at it over and over again.

In contrast, if you invested $1 in 1927 in a U.S. large-cap index fund and let it ride, your investment would have grown to $3,955 by 2014. Not bad. Vanguard and Dimensional alike prefer to invest in market “haystacks,” albeit with some procedural differences in how the assets get bailed, so to speak.

Electronic Market

 

Reason 2

Both minimize trading.

Trades cost money, in both overt and clandestine ways. By trading according to plan rather than trying to time the market or jump into “hot” segments, both fund companies are well-positioned to trade less often. Since trading is expensive, we can expect lower costs with reduced drag on performance if we trade less often.

The DFA Difference

Beyond just reducing trades by avoiding market-timing or trend-chasing, DFA’s structured trading strategy is part of its secret sauce. Actually, it’s not such a secret: When it comes to trading, a trader who is in less of a rush to buy or sell can usually command better prices than one who is in a rush or under pressure to trade. By being more patient than an index fund manager can be and a market-timing manager chooses to be, Dimensional has developed a solid track record for minimizing the trading costs involved in capturing the asset class returns they are seeking.

Moreover, DFA takes it one step further and offers its funds through select financial advisors who have demonstrated a similar level of patience. The result? Less frenetic trading and even net inflows during times of market panic. For example, during the 2008-2009 market panic, most funds experienced massive redemptions, which wreaks havoc on a mutual fund management. However, DFA funds actually had net inflows during that time, and was able to put that new cash to work and buy securities at bargain basement prices. (This is a mutual fund manager’s dream!)

Patient Investing

Reason 3

Neither firm tries to guess what asset class will outperform.

Vanguard and DFA offer funds with “style purity.” They invest in the asset class they say they will–small-cap value for example–and stay there. They aren’t making any kind of tactical bets that one asset class will perform better than the other.

The chart below says it all. Each column is the year, and each colored square is a separate asset class. Follow one color, such as “red” (the S&P 500), year by year. Look how much it bounces around! The performance of each asset class each year is anyone’s guess.

 

Callan Periodic Table

Reason 4

They don’t keep betting on the horse that won the last race.

Another common investment mistake is to chase stocks that have been on a recent winning streak and/or abandon recent underdogs. This continues to happen, despite the volume of evidence that past performance does not inform us about future returns.

Both Vanguard and DFA do not make “bets” on individual stock performance. They simply hold a large basket of stocks that fall into their well-defined criteria (in DFA’s case) or follow a published index (in Vanguard’s case).

The DFA Difference

DFA does not invest in public indexes like most of Vanguard’s index funds. The problem with public indexes is, well, they are public; everyone knows when a public index will change (and how it will change). Stocks tend to rise when it’s announced they will be included in a public index, and index funds will buy that stock on the effective date at the higher price.

This forces the index funds to “buy high,” which is exactly the opposite of what investors should do. It’s why Dimensional can afford to trade more patiently, as described above.

Here’s a nice visual to explain the concept:


Index REconstruction

Reason 5

Both firms make “going global” easy.

Only about half of the global market’s capital is in the United States. That leaves a big opportunity set outside our borders. Moreover, many of those other countries respond differently to economic forces, which has many benefits to investors (a portfolio of investments that “zig” while others “zag” can actually increase return and lower risk).

Both firms offer funds that cover broad sectors of foreign markets, so you can easily stay globally diversified.

The DFA Difference

DFA offers foreign funds (and even emerging market funds) with higher “tilts” towards small-cap and value stocks, which have historically been a source of higher long-term returns. They also “tilt” towards companies that have exhibited higher profitability. As an asset class, these stocks also have a history of higher returns.

Global Investment Diversification

Reason 6

They help to manage your emotions.

When you are well diversified, both domestically and in foreign markets, you reduce the risk of any one investment taking a nosedive, which can be unnerving and cause you to panic if you are over-concentrated in that investment. With many of Vanguard and DFA’s funds holding thousands of individual securities, the impact of a few dogs isn’t going to hurt as much. You aren’t as likely to panic sell when you have a global back-up plan.

Take a breath. Talk to your advisor. Don’t react emotionally to a buy high and sell low outcome.

Investor emotions

Reason 7

Both firms help you to see beyond the headlines.

We are bombarded daily with catchy headlines about economic facts that seem to be on the verge of derailing our investment strategy. It’s easy to get swept into the hoopla about rising (or falling) oil prices, currency fluctuations, or political tensions in other countries. By participating in the market according to a disciplined, evidence-based process, turning to fund managers who help you accomplish that, it’s easier to take comfort in the fact that you are a long-term investor with a well-diversified global investment strategy.

Financial News

Reason 8

They help you focus on the real drivers of returns.

Many investors believe the factors that affect their returns are stock picking and market timing. In reality, the bulk of your returns are actually driven by how you decide to split your money between stocks and bonds. (Well, another huge determinant is your ability to stay the course once you build your sensible portfolio, without succumbing to your human behavioral biases, but that’s a subject for another post, such as this one.)

Stocks

  • Stocks have historically offered a higher long-term return compared to bonds, but are more volatile.
  • Smaller companies have historically performed better than larger companies.
  • Value stocks have historically done better than growth companies (think WalMart vs. Groupon).
  • High-profitability companies have historically performed better than low-profitability companies.

Bonds

  • Longer-term bonds have historically had higher yields compared to shorter-term bonds.
  • Lower credit quality (“junkier bonds”) have historically had higher yields compared to higher credit quality bonds.

This is an important decision, so work with your advisor to design a suitable portfolio based on these core drivers of returns.

The DFA Difference

DFA regularly and closely collaborates with academic scholars, some of whom have been awarded Nobel prizes for identifying these factors or “dimensions” of higher expected returns. As such, they have been particularly early, strong and ongoing proponents of this sort of factor-based or evidence-based investing.

DFA Financial Researchers

Reason 9

These firms help you focus on what you can control.

One of the few things you can control in investing is your costs. Both firms offer funds at significantly lower costs than many of their actively managed peers. They also offer a more disciplined approach to knowing what your own fund investments contain, so that it’s easier for you (especially with the support of an evidence-based advisor) to build and maintain a portfolio that you can stick with through thick and thin in your quest to build personal wealth. By minimizing the angst and second-guessing involved when you’re not sure just what is contained within your holdings, your own overall costs can be minimized as well.

You are in the busiest (and most profitable) time of your life. Working long hours. Struggling to figure out the best investments for your retirement. (Time, what time?) Why not work with a financial advisor who can help you clarify your goals and develop and plan to reach those goals?

An advisor will help you focus on factors you control — asset allocation, structuring a portfolio that takes into account the real drivers of expected returns and your ability to handle risk, broad diversification, low expenses, low trading costs and tax minimization.

DFA Financial Control

Summary

Both Vanguard and DFA offer low-fee funds that operate on the principle that the market is an effective, information-processing machine that is nearly impossible to outguess.

DFA takes it one step further with some distinct tactics and also allowing for “tilting” towards areas of higher expected returns like smaller stocks, value stocks and higher profitability stocks.

The growth of these firms shows that investors are waking up to the reality that investment success is about capturing global market returns and keeping costs low, not about hunting down the next “rock star” money managers.

Teresa Staker
Teresa Staker
Administrative Assistant
p // 801-494-6047
Can you pick the next winner

Building an Evidence-Based Plan

InFocus April 2017

THE FOUNDATION FOR A BETTER WAY TO INVEST

“Control what you can control.” —David Butler, co-CEO, Dimensional Fund Advisors

By following the above five words from Butler, investors can help simplify their complex financial lives. Out of thousands of pages of scientific research, a cornerstone of evidence-based investing emerges: Control what you can control. Control the fees you pay and your trading costs. Control your tax efficiency and your asset allocation. Control how closely your emotions are tied to an up-and-down market. Bigger picture, you can take better control of your entire financial experience.

This month’s InFocus looks at foundational tenets of evidence-based investing to give you confidence when you think of where you are and where you want to go.

DIVERSIFICATION

“Diversifying your wealth across a variety of market risks helps you remain on course and in the driver’s seat, even when the road ahead is uncertain.” —Manisha Thakor, director of wealth strategies for women, the BAM ALLIANCE

For an example of why we stress the importance of having an internationally diversified portfolio, just go back a few weeks. The first quarter of 2017 closed strongly for developed international and emerging markets (up 7.4 percent and 11.5 percent, respectively). This came when many investors had cooled on international stocks after they significantly underperformed U.S. markets from 2008-2016. But not so long ago (2002-2007), the MSCI World ex USA Index returned 128.7 percent compared with 42.5 percent for the S&P 500 Index. Diversifying your portfolio so it has exposure to both U.S. and global equity markets allows you to capture market upswings and withstand its downswings over the long haul.
Can you pick the next winner

All of this underscores the importance of being diversified and — the topic we’ll address next — being disciplined.

DISCIPLINE

“Inactivity strikes us as intelligent behavior.” Warren Buffett

Buffett is really smart and really good at making money. But he makes an important point when it comes to someone having the ability to outsmart the market. “Success in investing doesn’t correlate with IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people in trouble investing.”

Too many investors buy stocks during upswings when all feels good and sell during downward spirals when uneasiness seeps in. This lack of discipline can cause investors to be on the sidelines when markets rebound, causing missed opportunities.

Cost of Mistiming the Market

The cost to investors when they miss the best one, five, 15 and 25 days of market performance during a 45-year period.

Patience and prudence are central to an evidence-based strategy. Stay true to your well-devised plan while rebalancing periodically. Doing so will keep your portfolio in line with your target allocations and will enable you to capitalize on buy-low/sell-high opportunities.

MANAGING RISK

 “The makeup of your portfolio depends entirely on your unique ability and willingness and need to take risk.” Larry Swedroe

 Swedroe, a prolific author and the director of research for the BAM ALLIANCE, says the ability to take risk is largely defined by the investment horizon, the stability of an investor’s income and the need for liquidity. Swedroe says the willingness to take risk can be succinctly summed up through the “stomach acid” test. Can you stick to your plan even when the market goes down for an extended period? This includes rebalancing — selling what has done relatively well or held its value and buying what has done worse. The need to take risk is determined by the rate of return that is needed for you to reach your financial goals.

Part 1 The Ability to Take Risk

Of course, the word unique is critical as well. The ability, willingness and need to take risk are highly personal decisions. They vary for each investor’s specific circumstances. However, you can view general guidelines for prudent asset allocation decisions by clicking here or the image.

FOLLOW THE EVIDENCE

“It’s just fun to do research, learn new stuff, and potentially have an impact on the way other people are thinking about the world.” Kenneth French, professor, Dartmouth College

No room for speculation, prognostication or hunches, the evidence-based world is rooted in decades of objective research on the long-term behavior of financial markets. We use that evidence to tilt portfolios toward the asset classes that have delivered the highest returns over the long haul and should continue to do so. Click here or the image to see the return profiles of distinct asset classes during the period of 1931-2016.

This research leads to plans that keep costs low, minimize risk and implement tax-efficient strategies. The evidence results in portfolios that are diversified domestically and internationally. Those same portfolios use fixed income to dampen volatility and address the risk tolerance of each investor.

Asset Class Returns 1992–2016

 

weston_wellington

A Look Back at 2016 Weston Wellington

Reposted from dimensional.com

Every year brings its share of surprises. But how many of us could have imagined that 2016 would see the Chicago Cubs win the World Series, Bob Dylan receive the Nobel Prize in Literature, Donald Trump elected president, and the Dow Jones Industrial Average close out the year a whisker away from 20,000?

The answer is very few—a lesson that investors would be wise to remember.

At year-end 2015, financial optimists seemed in short supply. Not one of the nine investment strategists participating in the January 2016 Barron’s Roundtable expected an above-average year for stocks. Six expected US market returns to be flat or negative, while the remaining three predicted returns in single digits at best. Prospects for global markets appeared no better, according to this group, and two panelists were sufficiently gloomy to recommend shorting exchange-traded emerging markets index funds.1

Results in early January 2016 appeared to confirm the pessimists’ viewpoint as markets fell sharply around the world; the S&P 500 Index fell 8% over the first 10 trading sessions alone. The 8.25% loss for the Dow Jones Industrial Average over this period was the biggest such drop throughout the 120-year history of that index.2 For fans of the so-called January Indicator, the outlook was grim.

Then things seemingly got worse.

Oil prices fell sharply. Worries about an economic debacle in China re-entered the news cycle. Stock markets in France, Japan, and the UK registered losses of more than 20% from their previous peaks, one customary measure of a bear market.3 Plunging share prices for leading banks had many observers worried that another financial crisis was brewing. As US stock prices fell for a fifth consecutive day on February 11, shares of the five largest US banks slumped nearly 5%, down 23% for 2016.

The Wall Street Journal reported the following day that “bank stocks led an intensifying rout in financial markets.”4 A USA Today journalist observed that “The persistent pounding global stock markets are taking seems to be taking on a more sinister tone and more dangerous phase, with emotions and fear taking on a bigger role in the rout, investors questioning the ability of the world’s central bankers to calm the market’s frayed nerves, and a volatile environment in which selling begets more selling.”5

February 11 marked the low for the year for the US stock market. While prices eventually recovered, as late as June 28 the S&P 500 was still showing a loss for the year. Meanwhile, a number of well-regarded professional investors argued that the next downturn was fast approaching. One prominent activist in May predicted a “day of reckoning” for the US stock market, while another reportedly urged his fellow hedge fund managers at a conference to “get out of the stock market.” A third disclosed in August a doubling of his bearish bet on the S&P 500.6

Throughout the year, some observers fretted over the pace of the economic recovery. The New York Times reported in July that “Weighed down by anemic business spending, overstocked factories and warehouses, and a surprisingly weak housing sector, the American economy barely improved this spring after its usual winter doldrums.”7

Despite all of this noise, the S&P 500 returned 11.9% for the year and international stocks8 returned 4.4% for US dollar investors (6.9% in local currency9), helping to illustrate just how difficult it is to outguess market prices. Once again, a simple strategy of embracing sensible asset allocation and broad diversification was likely less frustrating than fretting over portfolio changes in response to news events.

Every year brings its share of surprises. But how many of us could have imagined that 2016 would see the Dow Jones Industrial Average close out the year a whisker away from 20,000?

1. Lauren Rublin, “Peering into the Future,” Barron’s, January, 25, 2016.
2. www.djaverages.com, accessed January 6, 2017.
3. Michael Mackenzie, Robin Wigglesworth, and Leo Lewis, “Stock Exchanges across the World Plunge into Bear Market Territory,”Financial Times, January 21, 2016.
4. Tommy Stubbington and Margot Patrick, “Banks Drop as Global Rout Deepens,” Wall Street Journal, February 12, 2016.
5. Adam Shell, “Market Tumult Charts New Waters,” USA Today, February 12, 2016.
6. Dan McCrum and Nicole Bullock, “Growling Bears Provide Soundtrack for Investors,” Financial Times, May 21, 2016.
7. Nelson D. Schwartz, “US Economy Stays Stuck in Low Gear,” New York Times, July 29, 2016.
8. Source: MSCI. International stocks represented by the MSCI All Country World ex US IMI (net div.).
9. Local currency return calculation represents the price appreciation or depreciation of index constituents and does not account for the performance of currencies relative to a base currency such as the US Dollar. Local currency return is theoretical and cannot be replicated in the real world.

Past performance is no guarantee of future investment results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

Diversification does not eliminate the risk of market loss. There is no guarantee an investment strategy will be successful.

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.

© 2017 Dimensional Fund Advisors. All rights reserved. Unauthorized copying, reproducing, duplicating, or transmitting of this material is prohibited.