I've been getting a lot of questions lately about the passive mutual funds available through an advisor from Dimensional Fund Advisors (DFA), especially in comparison to the index funds available through Vanguard. There aren't a lot of “good guys” out there amongst the dozens of mutual funds companies on the planet. Bridgeway donates half of it's profits to charity. Charles Schwab, Fidelity, and Ishares offer a number of very low cost index funds and ETFs, although critics argue only because of the pressure from mutually-owned Vanguard. But two firms stand out amongst the others for their real commitment to passive investing, Vanguard and DFA. Most of you are familiar with Vanguard, a long-time champion for the do-it-yourself individual investor. You may not be as familiar with DFA, which although not as low-cost as Vanguard, and offered only through investment advisors, also offers a lot of great investment options which in many cases are better than Vanguard's offering.
What Does DFA Do That Vanguard Doesn't?
Index funds are great. Actually, they're not great, but they're so much better than actively managed funds due to their low costs and lack of underperformance that they look great in comparison. Like democracy and capitalism, they're the worst possible system, except everything else that's ever been tried. Indexing has its issues, and DFA has made a concerted effort to improve upon index funds without abandoning their most important aspects.
I had the opportunity to interview Weston Wellington, a vice president with DFA about the “DFA advantage.” Weston is a very reasonable and intelligent guy as evidenced by his careful phrasing and humility about what DFA does, and does not do. They do a lot of things very similarly to the indexers at Vanguard- i.e. invest passively (although he hates that phrase because it implies he isn't doing anything, preferring instead the word “equilibrium”) and keep costs low. But I'm going to focus on the differences.
The most significant thing that DFA and its network of authorized advisors do is to tilt portfolios toward small and value stocks. These higher risk stocks have higher expected returns. You can tilt a portfolio of non-DFA index funds to small and value easily enough, but many do-it-yourself indexers don't whereas very few users of DFA funds don't have a significant tilt to these risk factors. The research cited by DFA is that 96% of equity returns are explained by market, value, and small factors. The new “profitability” factor added on top of that is likely to add a small amount of additional value, although Mr. Wellington didn't want to be quoted about how big he thought that was likely to be. I asked him whether he felt the additional expected return with small, value, and profitable stocks was a “risk story” (i.e. small, value, and profitable stocks are riskier and thus carry higher expected returns) or a “free lunch” (i.e. diversification to additional risk factors actually makes the portfolio less risky). Weston was decidedly in the “risk” camp emphasizing that the future may very well not resemble the past and the risks of small, value, and profitable stocks may very well show up in the future and provide lower than market returns over a long time period.
Aside from tilting toward additional risk factors, DFA also does a number of “little things” that give their funds a bit of an edge over a comparable Vanguard fund. They like to divide these up into management, engineering, and trading. The management refers to designing an “equilibrium” (i.e. passive) portfolio so it is appropriately tilted to compensated risk factors. Engineering refers to applying their eligibility rules for a given fund. For example, they exclude REITs from their small cap value fund, arguing that they are essentially different beasts and a different asset class. Another eligibility rule they use is that they don't buy stocks unless that stock has at least 4 market makers. They also do not let an outside provider (such as a commercial index) dictate what stocks they should hold. Tracking error against an index doesn't bother these guys. Rather than reconstituting quarterly or yearly as many indexes and the funds that follow them do, they do it each day as stocks increase or decrease in value. DFA uses its “core funds” to further decrease turnover costs. Trading refers to their patient trading philosophy. They use buffer zones to so that they can trade smartly, minimizing trading costs. They try to be providers of liquidity rather than paying a liquidity premium. Along those same lines, they do security lending (lending securities to short sellers) to further boost returns.
DFA also tries to minimize turnover within the fund by forcing their investors to use some of the most highly-educated advisors out there. Many of them are CFAs, essentially the highest designation for an asset manager, and they have attended a number of seminars so they understand the academic research and exactly what DFA is trying to do. Their theory is that an investor guided by an advisor is less likely to be trying to time the market by jumping in and out of the funds and less likely to bail in a down market, minimizing costs and boosting performance for the fund. DFA actually started out investing only institutional money, but started bringing on individual investors only because of the guarantee from advisors that they wouldn't get “hot money.”
So How Does DFA Do?
A number of smart individual investors have wondered whether it is worth it to hire a DFA authorized advisor just to get access to DFA funds. They've tried to do their best to compare apples to apples using a similar collection of non-DFA funds to DFA funds and tried to determine just how big the DFA advantage is, especially AFTER the cost of the advisor. Obviously for an investor who values the other services of the advisor, that may not be a fair comparison. I'm convinced that for some investors, they'd be better off paying an advisor 5% a year than doing it on their own. But for the intelligent investor with a reasonable demeanor, is it worth hiring an advisor JUST for access to the DFA funds? This question becomes more and more relevant as advisory fees drop, sometimes as low as $1000 a year from a firm like FPL Capital (one of my advertisers) or Rick Ferri's Portfolio Solutions (as low as 0.37% a year with a minimum of $3700 per year). More traditional firms tend to charge around 1% a year for assets under management.
For some asset classes, such as large US Stocks, DFA doesn't seem to make much of a difference. DFA's large company fund (DFUSX) is very similar to Vanguard's 500 fund (VFIAX), although it charges a slightly higher expense ratio (10 basis points vs 5 for the Vanguard fund). The performance difference? According to Morningstar, DFUSX has had an average annual return (arithmetic) of 7.96% per year for the last ten years, compared to 7.94% per year for the Vanguard fund. Am I going to pay 0.37%, much less 1% to get DFA access to that fund? No way. For other asset classes, however, the difference is larger.
Some of the Bogleheads and a number of DFA authorized advisors have tried to make comparisons between the two, but in the quest to compare apples to apples, the results tend to differ enough due to different methodology that it's hard to get an exact answer. Altruist Financial Advisors has a discussion of DFA vs Vanguard (and some recommendations for each asset class) on their site. FPL Advisors, one of my advertisers, has something similar on their site. Rick Ferri and Larry Swedroe, other well-known authors and DFA authorized advisors use both DFA funds and funds from other companies like Vanguard and Bridgeway in their portfolios. Tom Martin, at Larson Financial Advisors, gives clients a comparison sheet which can give you some idea of the size of the “DFA advantage”. This is my attempt at a comparison.
DFA Vs Vanguard
| 10 Year Returns | ||||||||
| Asset Class | Reasonable Index | DFA | DFA ER | Non-DFA | Non-DFA ER | DFA | DFA – 1% fee | Non DFA |
| US Large Stocks | S&P 500 | DFUSX | 0.10% | VFIAX | 0.05% | 7.96% | 6.96% | 7.94% |
| US Small Stocks | CRSP US Small Cap | DFSTX | 0.37% | VSMAX | 0.10% | 11.42% | 10.42% | 11.73% |
| US SCV Stocks | CRSP US SCV | DFSVX | 0.52% | VSIAX | 0.10% | 12.16% | 11.16% | 10.87% |
| Microcap Stocks | CRSP 9-10 | DFSCX | 0.52% | BRSIX | 0.87% | 10.87% | 9.87% | 9.59% |
| Intl Developed LC | FTSE Dev Ex-NA | DFALX | 0.30% | VDMAX | 0.10% | 8.94% | 7.94% | 9.03% |
| Intl Small | FTSE Global SC Ex-US | DFISX | 0.56% | VFSVX | 0.45% | 11.12% | 10.12% | 9.42% |
| Emerging Markets | FTSE Emerging Index | DFEMX | 0.61% | VEMAX | 0.18% | 15.99% | 14.99% | 15.64% |
| US Real Estate | MSCI US REIT | DFREX | 0.18% | VGSLX | 0.10% | 12.14% | 11.14% | 12.52% |
| TIPS | Barclays Series L TIPS | DIPSX | 0.13% | VAIPX | 0.10% | 6.17% | 5.17% | 5.70% |
| Corporate Bonds | Barclays 5-10Y Credit | DFAPX | 0.22% | VFICX | 0.20% | 2.92% | 1.92% | 5.58% |
| ST Federal | Barclays 1-5Y Gov | DFFGX | 0.20% | VSGDX | 0.10% | 3.14% | 2.14% | 3.37% |
I tried to be as fair as I could with the data and compare apples to apples as much as possible. Ten year average annualized returns as reported on Morningstar on 5/15/13 were used wherever possible (Intl small used 3 years, corporates used 1 year). When looking at the asset classes where the DFA and non-DFA portfolios are very similar (US Large, Intl Small, EM, Real Estate, and TIPS), DFA won 2, non-DFA won 2, and we'll call US Large a tie. Subtract a 1% management fee, and the non-DFA funds handily win 4 out of 5.
Apples and Oranges?
Some of the portfolios are fairly different, for example the average stock in the DFA Small Cap fund is half the size of the one in the Vanguard fund. Likewise, the average stock in the DFA Micro Cap fund is over 3 times the size of the one in the Bridgeway fund and the Bridgeway fund is far more valuey. Vanguard's SCV fund is nearly as valuey as the DFA fund, but not nearly as small. The DFA international developed fund includes Canada, but the Vanguard one does not. This makes the comparison difficult.
I asked Mr. Wellington about quantifying the DFA advantage. He points out that over the last 31 years DFA's small cap fund has outperformed the Russell 2000 by 165 basis points (1.65%) a year but he is careful to note that may not persist. He admits the advantage may be much lower in other asset classes. As noted above, much of that 1.65% may be explained simply by the fact that the DFA fund holds much smaller stocks than the Russell 2000.
Entire Portfolio
What about the entire portfolio? If I made two portfolios using these asset classes, one composed of the DFA funds and one composed of the non-DFA funds, I could figure out what the “DFA advantage” really would be. A priori (just like I chose the asset classes above), I decided my asset allocation would be 15% US Large, 5% US Small, 5% US Small cap value, 5% microcap, 10% international developed, 5% international small, 7.5% emerging markets, 7.5% real estate, 15% TIPS, 10% corporates, and 15% Federal bonds, for a 60/40 portfolio where 37.5% of the equity is international. I then calculated the DFA advantage. I calculated it out to be a MINUS 0.04%, or essentially a tie. That was before any advisory fee, but any advisory fee you add on is going to make the DFA portfolio look even worse.
There's No DFA Advantage?
Well there could be. If your portfolio was more heavily tilted toward those asset classes where DFA seems to do very well, like small cap value, international small, EM, and TIPS, then there would be. Your advisor may also choose to use non-DFA funds where they appear to be superior. But certainly any reasonable interpretation of the data would not justify a statement that DFA funds were dramatically better than the alternatives, and certainly not sufficiently superior to justify the hiring of an otherwise unvalued investment advisor. However, if I were going to hire an investment advisor anyway (I'm not of course), I would definitely make sure said advisor had access to DFA funds. Not only would that give me access to those funds, but it would also ensure my advisor was reasonably well-educated with regards to the academic investing literature and knew the importance of developing a good plan and staying the course with it.
I asked Mr. Wellington directly whether a disciplined, educated do-it-yourself investor should hire a DFA-authorized advisor just to get access to the funds and his answer was an emphatic no. He based his argument on philosophical factors, however. He felt that if the only reason you were hiring an advisor was to boost performance by access to better funds, and didn't value the other things the advisor brought to the table, like portfolio design, maintenance, and what diehard do-it-yourselfers like to refer to as handholding, then every time you met the focus would be on “performance, performance, performance” and that the relationship wouldn't be very satisfying to either of you, especially when the inevitable, hopefully temporary, underperformance versus a do-it-yourself portfolio occurs.
I also asked if they'd ever consider allowing individual investors direct access to the funds. He noted they weren't staffed to service individual investors directly and also that he felt the number of individual investors out there who had the knowledge and temperament to manage their own portfolio were so few that it wasn't worth it, pointing out that “even Tiger Woods has a golf coach. Most investors just can't sit still and get market returns.”
So in the end, if you are an educated and disciplined investor, don't go out and hire an advisor just to get DFA funds. There is probably an advantage there, especially in certain asset classes, but it isn't large enough to pay for the advisory fees by itself. But before you decide to do it on your own, you'd better be sure you're sufficiently educated and disciplined to implement and maintain an intelligent portfolio over the long run.
What do you think? If DFA funds were available without any advisory relationship which ones would you use? Have you considered hiring an advisor to get access to DFA funds? Comment below!
Thanks for an awesome article. I would like to use DFA for certain funds that are not easily available via other providers e.g. emerging market value etc. I therefore need the lowest cost access without advice. Which advisors are the lowest cost providers who would be willing to let me buy the fund without charging for advice?
Thanks
Al, to the best of my knowledge that info is actually in the article. FPL, Ferri, etc.
I should clarify, Ferri is very cost effective (depending on AUM amount) however he won’t just let you have access to DFA funds without guidance. At least that is my understanding.
Nice article. I have been contemplating incorporating DFA and other passive+ families into my portfolio. I agree that if you are a knowledgeable and disciplined investor it isn’t worth the .7-1% surcharge for access. If you need guidance there is no doubt that it is.
Another issue that crosses my mind is that I am pretty confident of what Vanguard will look like 20-30 years out. I can’t say the same for DFA or certainly the others. Although Sinquefield has retired I believe, what happens when Booth goes? What will the expenses be like relative to the lowest cost Vanguard, Fido, and Schwab offerings? Who is to say that DFA’s expertise won’t filter down to the more retail-oriented shops thereby narrowing the pure performance gap? The new momentum and profitability factors intrigue me right now because they are additional things that may distinguish a passive+ portfolio.
Another point that perhaps deserved to be highlighted is the Swedroe philosophy of using these smaller/valuey funds in order to get the same amount of access to the factors with less overall equity exposure.
Some additional related info:
A nice brief article by Vanguard on their general indexing philosophy:
https://personal.vanguard.com/us/insights/article/index-funds-05042011?z_rl=T18084&utm_content=sf446355&utm_medium=spredfast&utm_source=twitter&utm_campaign=Personal+Investor&sf446355=1
Another option for those who would like to use some DFA funds without an advisor is to get them through the Utah 529.
DEFINITELY the way to go if you are saving for a child’s college expense, but not much of a “back door” for other savings. Thanks for the tip!!!!
DFA or any mutual funds should be limited to a 401(k). I prefer to use individual stocks and ETFs in taxable accounts for tax purposes, but also in IRAs because I like the ability to enter and exit mid-day if a major market condition warrants it. That flies in the face of buy and hold, but the power of staggered trailing stops can be a huge money saver in a bear market. You can’t automate those with any mutual funds that I know of.
On the DFA vs others question, I’d be more incline to use them if they didn’t have the cult-like attitude and require advisors to travel to their seminars in person before being authorized. That cost just gets passed to the clients and is why I don’t use DFA.
I disagree about mutual funds just in 401Ks. I find the ability to trade intra-day is not particularly important to long-term investing success. In fact, I find it a pain since I actually have to trade during the day. (I use ETFs in my 401K and HSA as expenses are lower than using the funds in the 401K/HSA and mutual funds in my IRAs.) If you live in Hawaii, the markets are closed by 11 am. If you work a lot of night shifts, it might be two weeks before you’re awake while the markets are open. I’m also not a huge fan of stop-losses. I find them a form of selling low. Is it possible they can save you a lot of money? Sure. They can also cause you to lose a lot of money when you get “whipsawed.” But I agree there can be a bit of a “cult-like” attitude with DFA. I haven’t attended the seminars, but my assumption was that there was a fair amount of educational value to them, which I think is probably beneficial to an advisor. If nothing else, if you use a DFA-authorized advisor you know that they’ve at least been exposed to the academic literature on passive investing.
I agree that ETFs lose their advantages quickly for some people. I’m on the east coast (Atlanta) and in front of my computer most of the trading day, so my stance doesn’t work for most of your readers.
I offer my clients both active and passive portfolio management and explain the potential risks and rewards for both sides. To my surprise, the majority of the more active investors I have are the ones who are looking for safety rather than market outperformance. Those who have done a good job saving tend to be more cautious about not losing it in the next correction. A good portion of my job is convincing clients to stay invested in rough times.
I believe market timing has its place with investing. Dumping bonds when rumors started building about Fed tapering was an easy way to miss the worst of the decline in what too many investors think is a safe haven.
The staggered trailing stop loss orders I use sell on declines in a graduated scale. For example, I might sell 5% of a portfolio after an 8% drop, then another 10% after 12%, 15% after 16%, etc. If I’m whipsawed, I only miss small percentage of a total account. If the market keeps falling, I’m 30% in cash by the time the market is down 16% (in this example). I continue to cut as prices fall. Doing so all at once is far too dangerous, especially with how quickly the markets move lately.
Just like making little tilts to a portfolio has less dramatic consequences when you’re wrong, so does just a little bit of stop loss orders. But I don’t think the size of the effect has anything to do with whether it is a good idea or not. You can get whipsawed just as easily with 5% of the portfolio as with 50%. You still have the same issue. If the market goes down 16% and then comes right back up, you still sold 30% of your holdings low. It’s market timing and there is little data that anyone (and that includes you and I) can do it well over the long-term. It comes with additional expenses (such as hiring you to do it) and taxes that must be overcome by alpha to make it worth it.
It all sounds very sophisticated, but if it were some guaranteed way to ensure a higher risk adjusted return, everyone would be doing it. The other issue is that your sell order goes in when the market drops 12% (or whatever) but that doesn’t guarantee you actually sell the security at only a 12% loss. In times of illiquidity, a stop-loss order that activates at 12% down might actually sell at 20% down, no? Just when you most need a stop-loss order, it doesn’t work. It seems much better to be a supplier of liquidity when it is scarce, rather than a demander of it.
The studies that support stop-loss orders as measured against a buy and hold portfolio (such as this one: http://lup.lub.lu.se/luur/download?func=downloadFile&recordOId=1474565&fileOId=2435595) don’t seem to take that loss of liqudity into account. The assumption is that you’ll always be able to make a trade at the price you want. I don’t necessarily buy that empirical data is going to reflect the theoretical data. You don’t have to spend much time on their assumptions section to see that there are some serious design flaws in the study:
4.3
Assumptions
We make an assumption that the stop-loss orders are
exercised only at the end of the day,
allowing the stock price to freely fluctuate during
the day.
Another assumption made is that when a stop-loss or
der is to be executed due to the adverse
price development, the order becomes a market order
and is executed at the market price at that
moment. We allow for the possibility of slippage so
the market price is assumed to be the
closing day price which most certainly will be belo
w the stop loss order price.
Next assumption is that positions are sufficiently
small and do not affect the market price.
We also assume that the market is generally efficie
nt, therefore it is of a minor importance when
and which stock is bought.
Finally we do not consider transaction costs since
utilizing stop-loss rules in our case leads to
the same number of transactions, hence the transact
ion costs are the same for stop-loss and the
buy-and-hold strategy
No consideration of transaction costs? Really?
Now, I don’t discount the behavioral/psychological value of using stop-loss orders, and perhaps with the skittish clients you describe, knowing that 30% of their money is out by the time of a 16% loss helps them avoid selling out of the other 70% of their portfolio, but one has to wonder if that type of client should really have such a high equity allocation in the first place, no?
These conversations bring me back to wondering what really is the evidence for much more than a 3 fund portfolio. Some tilting with small value seems to be useful because of higher risk but even if you add just a little of that, there seems to be little evidence to go beyond the now 4. Once you keep it small then it is so much easier to do without an advisor and then the 1% or whatever AUM is so much easier to keep. To be honest, i actually dont own a 3 fund portfolio but i doubt i could defend any of my tilts on a risk adjusted basis. Most tilting in my view winds up being market timing except that the person doesnt want to call it market timing. They think now is a good time to tilt emerging markets or whatever and supposedly they will know when its a good time not to tilt in that direction. Fortunately tilts usually imply a small position overall.
The lowest cost DFA advisors for anyone with a decent sized portfolio (over $810,000 or so) are going to be the flat rate guys…EVANSON ASSET Management and CARDIFF PARK Advisors. On the Evanson website they have some data that supports using DFA that incorporates more than just the last 10 years. As anyone can tell you, the supposed advantage of DFA may or may not be there for a limited time frame and may not be true in the future, but I believe the DFA approach along with sound advice is worth the small fee(0.1% and falling- as it remains flat as my portfolio grows)that I pay Evanson right now for the long run is a sound use of my money.
That’s a very cheap price for sound advice, no doubt about it. I agree that flat-fee advising is cheapest for anyone with a decent size portfolio. Even Ferri’s 0.37% is more than $10K a year when you have a $3 Million portfolio. I’d like to see a lot more asset management available for a flat annual fee and a lot more financial planning available on an hourly basis. The AUM fee sometimes seems almost as sneaky as using loads and commissions. “It’s just 1% a year” (even if that means $20K for 10 hours of work.)
Clearly, if you are going to an investment advisor simply for DFA access, you are going to go to one with the lowest fees, not 1% or something similar for a full-service relationship. You don’t want/need full service, why pay for it? Apparently, if the ads above are the benchmark, the going rate for “DFA facilitation” are $1,000. That’s what you would pay. On $1M, that is 0.1%. Not even worth batting an eye over.
When you do go to a professional full-service advisor (who charges much more than $1,000), you get a range of services including a customized asset allocation and considerable ongoing education and counseling, not to mention wealth management. For many investors, that service is priceless. And it certainly is absurd to apply this rate to the desired “DFA conduit service”.
Finally, setting aside this fee/service confusion, often when I see DIYers doing a DFA vs Vanguard (or index) comparison, the allocations make me wince. That might be how their portfolio looks, but not how a halfway intelligent advisor would design things. I’ll look at two fairly common mixes I use — an all-equity allocation, and a balanced 65% stock, 35% bond mix.
For my equity mix, we have 20% DFA US large, 20% DFA US large value, 30% DFA US small value, 10% DFA int’l value, DFA int’l small value, DFA emerging value. (in reality, the new profitablity-enhanced DFA US large growth fund should be first instead of DFA US large, but it lacks the live data).
For Vanguard, we’ll use the same allocations spread across 500 Index, Value Index, Small Value Index, Int’l Value, Int’l Explorer, and Emerging Mkts Index.
For the 65/35 mixes, we’ll just dilute the equity allocations by 35% and add DFA 5YR Global and Vanguard ST Bond Index respectively. I use the former, but if DFA went away tomorrow I’d happily use the later.
On the all-equity side, the DFA mix wins by 1% and 1.5% annually for the last 10 and 15 years through 7/11. On the balanced side, the DFA mix wins by 0.8% and 1.1% for the last 10 and 15 years through 7/11. You can quibble about factor loads/weightings/risk or whatever, but I notice that for the last 15 years, the 65/35 DFA fund mix (with 35% in high-quality bonds) outperformed the all-equity Vanguard allocation–that’s higher returns with far less risk. Or we could discuss how the negative correlation amongst market/size/value dimensions means a multifactor portfolio with purer exposures (DFA) means the higher stand-alone risks are offset by enhanced diversification benefits, bringing us right back to apples:apples. So that’s a non-starter.
Anyway you slice it, those levels of outperformance are greater than the fees that a reasonable full-service advisor charges (in the 0.75% to 0.5% range depending on asset size), so it looks like some investors are getting what they pay for and then some (the additional counseling and wealth management insights along with net-of-fees outperformance).
Also, I don’t actually see DIYers invest like the Vanguard portfolio I’ve set up. I see them using the 3 fund portfolio — Vanguard US Total Stock Index, Total Int’l Index, and Total Bond Index. For the last 10 and 15 years they trail my DFA fund examples above by a whopping 2.2%/3.6% on the all-equity side and 1.1%/2.0% for the 65/35 split. And, over the last 15 years, the DFA 65/35 mix outpaces the all-equity (far greater risk) total stock split by 2% per year. So if we are being honest about the outcomes of DIY investors choosing the most common approach, we see significant “opportunity costs” that far outweigh all but the most overpriced fee-only firms.
In a conversation with a dyed-in-the-wool DIYer the other day, he candidly admitted to me “I don’t even look at the returns anymore”. Well, that’s one way to reduce these costs…ignore them!
Finally, as for the future, it’s hard to see things changing. If anything, the spread will only widen in favor of the most well-engineered asset class funds and structured allocations. Additional considerations for profitability have the potential to add 0.5% to 1% to existing portfolios while reducing risk (the profitability factor is negatively correlated to the value factor).
And, human nature being what it is, the biggest cost of all — bad behavior — ain’t going away anytime soon. Just skim the Bogleheads board, in 2008 it was “why do we need ANY stocks?”, in 2010 it was “should I put everything in the Permanent Portfolio?”, today every other thread is a full-on panic about bonds and rising rates (and market-timing the bond allocation). John Bogle’s saying the Total Bond Index is broken (not enough corporate bonds), as much as 0% international is OK? It certainly doesn’t look good.
Enjoy the blog. Good luck!
One thing that people fail to realize about many DIYers is that they would rather make a little less money over the long term than having to enrich a stranger JUST TO GET ACCESS TO DFA FUNDS!! I have met many people who use Vanguard index funds; they tilt towards Value and Small Cap; they rebalance regularly; some of them even LOVED 2008-2009 as they put more money to work in equities (buying low while others were running). These people don’t need help with asset allocation and they don’t need to be talked off the cliff when things get ugly.
You can say they are being silly/foolish for not wanting to pay an advisor when they can clearly benefit, but it goes against the very nature of their independent investing spirit. Perhaps, DFA will one day offer to vet clients as a way to get at their funds. The people I describe here certainly have much more integrity than the vast majority of “professional” advisors out there that are just “pushing product.”
And, if you happen to be one of these DFA advisors showing/telling DIYers about the superiority of your funds…forget about it. DIYers hate a salesperson more than anything!!
Assnap Kined
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I wouldn’t count on DFA “vetting clients.” It didn’t sound to me from my interview that they have any interest in that at all. But who knows what the future will bring.
Eric I am curious as to why you don’t use the DFA Core funds at all? Use that as your “core” and then tilt from there…
I should add that I assume this is EDN from bogleheads. I miss the input from the DLA guys on that site. I find it all very interesting and with the newer factors potentially coming into play the discussion can continue about the pros and cons of passive+ compared to Vanguard.
Thanks for the lengthy comment Eric.
I think we’re probably in agreement on most subjects. However, I disagree that 1% should be expected for a full-service relationship. At what annual price would you offer a full-service relationship? $5K? $10K? Surely not $30K? But for someone with a $3M Portfolio, 1% is $30K, and IMHO that’s just too much. FPL, Cardiff, and Portfolio Solutions are all doing asset management for less than $5K. That doesn’t surprise me. There isn’t THAT much to it. I think a lot of advisers like to think they offer “a higher level of service” and that’s why they charge more. I guess I’m not convinced. It seems to me that just about every investment adviser I’ve ever met is willing to meet with you for just about as much time as you can stand to meet with them. Most clients who hire an adviser just want someone “to take care of all that stuff” so they don’t have to worry about it. They’re not looking for a gazillion hours from their adviser. Most of the work is all up front anyway. That’s neither here nor there though. A successful adviser doesn’t have to convince everyone (much less diehard DIYers) that his fees are worth it. He only has to convince a few dozen people to have a viable career and business. And if he’s worth it to them, then more power to him. But I want people to be aware that lower prices are available, then they can decide if they want to pay more for “more service.” The Wal-mart model would suggest that for most stuff in life, people are just fine with the lowest-cost option for what they’re looking for. The toolbox I bought at Wal-mart the other day was of higher quality and for a lower price than at another store I looked at. Price matters in everything, and that includes portfolio management.
Regarding the allocations (and disregarding the “halfway-intelligent” comment), your suggested equity portfolio is 80% value. That’s a pretty significant tilt. You’ve got to be a big believer that the value effect is likely to persist throughout your investing horizon and have zero problem with tracking error to widely publicized market indexes to go for such a portfolio. I’m not saying it won’t work. The past data looks good. But there isn’t that much past data. If you’re willing to go 80% value, why not 100%? Heck, why not 100% small value profitable. The reason why is that at a certain point, additional diversification to factors becomes too little diversification to different companies and sectors. Every investor always needs to consider the answer to the following question when designing a portfolio- what if I’m wrong? What if value doesn’t outperform growth over the next 50 years? What if the profitability factor was just a result of a certain period of time? You’ve got to hedge against being wrong. I don’t think an 80% value portfolio (it’s actually higher since the 20% in large includes large value stocks) does that enough.
You also threw in Vanguard Explorer. Last I checked that wasn’t a value fund. It’s the whole apples to apples problem you acknowledged. It really matters because some people who don’t get into this stuff would look at your conclusion, see the “1-1.5% or more” figure and decide to hire an adviser at 1% a year.
At any rate, I picked what I felt was a reasonable tilt a priori and was actually quite surprised with the results. I also noted in one of the last paragraphs that if you were willing to tilt heavily to the asset classes where DFA seems to excel, perhaps you could do much better with a DFA portfolio, which I think is your point.
I’m skeptical that adding a factor (profitability) which as I understand it is only helpful if added on to the small and value factors, can really add 1%, but the future will answer that question and it doesn’t matter what your or my opinion about it is at this time.
I really liked your last paragraph. Thanks for participating.
Hi, Jim. Great blog, and some of the better comments in the blogosphere.
I won’t rehash everything that’s been written so far, but I’d like to add a clarification (full disclosure: I’m a member of the BAM Alliance and DFA funds make up the majority of my clients’ portfolios): Every “full service” advisor I know has a tiered fee schedule — mine is 1% on the first MM, 80 BP on the second, 60 BP on the third, and so on — so that a $3MM portfolio would be paying something lower than 1% (in my case, 80 BP).
To Mr. Kined: I agree with Weston Wellington; I would never recommend hiring an advisor solely to get access to DFA funds. I make NOTHING from putting my clients in DFA funds vs. Vanguard or any other funds. I believe the evidence (generally) supports the benefits of using DFA, but when I think a non-DFA fund better represents an asset class or fits better in a particular portfolio, I use that instead. (More precisely, I recommend that fund instead, since I recommend, not dictate, to my clients.) Am I right when I think DFA is better? Well, I think I’m right, of course; otherwise I wouldn’t hold that position. But I’m well aware I could be wrong with respect to any given fund. Far more important than the DFA-Vanguard debate is the active-vs.-passive debate (passive wins, hands down) and proper asset allocation. There are doubtless many DYI investors who know what they’re doing and who have the intestinal fortitude to stick with their plan. But I can tell you from personal experience that there are many, many investors who, by their own admission, DON’T know what they’re doing and/or don’t have the stomach to stay the course in a bad market. And many are just simply too busy making money and living their lives to learn how to properly invest and would rather pay someone to help them. Is my fee, then, worth it? As Warren Buffett said, “Cost is what you pay. Value is what you get.” For my clients, I believe I provide value. Ultimately, it’s up to them to decide.
I had a conversation an hour ago with a doc who is exactly what you describe- she wants to pay a fair price for good advice and good service and certainly does not want to manage her own investments. I think the majority of docs are like that. I also agree that the passive-active factor is FAR LARGER than the DFA-Vanguard factor.
I think this was a well balanced article and I came to much the same conclusion a couple years ago when researching the DFA vs Vanguard differences. I was comparing the IFA 100% equity aggressive portfolio to a Vanguard portfolio with the same tilt and I came to much the same conclusion – that before expenses there was no appreciable difference. When I tried to discuss this with the IFA advisor, his only explanation was that you usually need to look at a very long time frame such as 50 years to see a difference. When I commented that I was approaching 60 at the time and did not see 50 years in my future, he really had nothing more to say.
In my opinion DFA is one of those companies that tries to use the word index into the area of active management, as evidenced by some of your comments:
“Another eligibility rule they use is that they don’t buy stocks unless that stock has at least 4 market makers.”
——– wow an index that tracks market maker behavior!
“They also do not let an outside provider (such as a commercial index) dictate what stocks they should hold. Tracking error against an index doesn’t bother these guys.”
——– in other words they pick their own stocks based on their own set of rules, much like an active manager would do!
fd
While there are many “casual opinions” expressed above, I did not see any reference to independent research on the subject.
Below is a link to a study by 2 university researchers as to the performance differences between Vanguard and DFA. The link to the complete 25-page paper is:
http://public.econ.duke.edu/Papers//PDF/Vanguard_Versus_DFA_30%20july_2007.pdf
The study concluded that DFA’s performance relative to Vanguard’s, “has been impressive”. For the 8-year time frame studied. The findings included:
1. DFA outperformed Vanguard by 8.9 percent per year.
2. The DFA portfolio outperformed Vanguard’s style-mimicking portfolio by 2.57 percent per year. This reflects the quality of DFA funds relative to Vanguard’s as well as the choices that DFA advisors and their clients make.
3. The DFA portfolio of domestic funds beat the style adjusted portfolio of Vanguard domestic funds by 2.61 %/year continuously compounded.
4. The corresponding differential for the international funds was 3.59 %/year continuously compounded.
5. The DFA portfolio outperformed Vanguard’s Fama-French load-mimicking portfolio by 1.4 or 3.0 percentage points per year, depending on the method of analysis.
6. The DFA constant-style portfolio over the entire 8-year period (using beginning period weights) outperformed the style-mimicking Vanguard portfolio by 2.7 percent per year. This reflects the quality of the DFA funds relative to Vanguard’s.
Based on these findings (which entailed much more time and prudent process then contained in the comments above) it seems there is a larger difference than what the reader may get on a simple comparison as expressed in the original article.
Based on the researchers numbers for that 8 year time frame, even if an investor paid 1% ( which is high) to use an investment advisor, they would come out ahead, not including no further value add using an advisor.
“Based on these findings (which entailed much more time and prudent process then contained in the comments above)”
so much time they could only examine 8 years?
Do you seriously expect to see 8%+ going forward? I don’t expect to see 1% going forward. I do agree with you that 1% is high with regard to advisory fees however. Another study by Ed Tower (noted below) found very different conclusions, but over a different time period. It would be much more helpful if Ed would study the longest possible time period, but he lives in the “publish or perish” world, so more publications is better!
Mike here is a more recent study by Tower that concerns DFA’s Core Funds and is much less impressive. Actually it is unimpressive…in my mind it is more evidence that properly constructed portfolios are very close. Here is appears that no REITS played a major role in the DFA under performance for the short period that was examined.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2179188
I realize I’m late to the party but I found this thread quite fascinating.
Let’s keep in mind that we all have blind spots as investors and that’s why we continuously search the evidence for answers. It’s also why if you ever challenge Eugene Fama (congrats on the Nobel Prize Monday by the way) about his work he gets intrigued rather than defensive; he’ll actually light up and say, “That’s interesting; let’s test it.” This exemplifies the attitude we should all have.
Here’s a recap of some of the basic information we have about DFA. DFA has historically attempted to optimize returns using various strategies in conjunction with the three factor model. For example, they’ve had some success reducing net expense ratios on their funds through securities lending; they’ve avoided some of the drag that standard index reconstitution has on returns; they’ve had some success negotiating block trades at below market prices; and they’ve used some modest momentum trading strategies that have worked a little more than they’ve not worked. Over various time periods the value added by these strategies has fluctuated just as the premiums on the three basic risk factors have. As an aside, I’ll mention their risk reduction strategy of requiring at least four market makers does reduce liquidity risk although it may go unnoticed until markets start to seize and prices plummet.
Lately we’ve learned that adding a more robust momentum strategy and/or a profitability tilt to an overall investment strategy appears to make sense (assuming they can be implemented cost-effectively). This is true not only due to the absolute (though ever changing) size of the factors (i.e. the actual gap being measured when we run hypothesis tests on them) but due to attractive (low/negative) correlations with other dimensions of return. As a counterpoint some have questioned how the profitability effect can exist given that any potential excess return should have been priced into the securities beforehand.
From the beginning we’ve understood that DFA seeks to identify and capture factors that drive returns – factors that are persistent (continue over time), pervasive (appear across markets), and make some sort of sense (a test the January effect didn’t pass before it finally dissolved – this is also why bonds statistically beating stocks over a decade where rates fell obviously doesn’t mean there’s no more equity risk premium). This is more or less what we know about DFA.
Now I’ve used Vanguard almost as much as DFA over the years but if I gravitate toward DFA it’s because I appreciate and value DFAs strategy of identifying and maintaining consistent exposure to the scientific factors that drive returns. Whether that’s active management or passive management I appreciate that DFA has a clear, consistent and empirically rigorous methodology that I can test myself and either reject or accept based on scientific principles. Aside from any performance advantage, the consistency and clarity of the DFA mandate has value.
Of course if investors can effectively capture their target exposure to the factors that drive returns using Vanguard that’s great; if they prefer to use DFA to accomplish the same thing that’s okay too. What’s important is to focus on the factors that drive returns over the long-term and avoid confusing strategy with outcome in the short-term. Confusing strategy with outcome often occurs when comparing strategies over short (e.g. five year) time periods. Differences over short time frames could be the results of several things including poor strategy execution on the part of the fund company (e.g. style drift), measurement error / benchmarking error (using a model that’s incorrectly specified or comparing a strategy against one that isn’t implementable in real life) or it could just be the manifestation of other forces during that small window in time.
At the end of the day it’s more important to find the best way to implement an evidenced-based strategy than be dogmatic about any particular method. This is because with investment strategy it normally takes many years to know if we’re really onto something and also because we all have blind spots and there’s always more to learn.
Steve
I think an important aspect to remember with the fees associated with DFA–in managed account situations–is that investors are not simply paying for access to DFA funds. Investors are paying for a managed account. They get access to DFA funds AND the recommended asset mix after going through a careful discussion of their goals and a risk tolerance evaluation. The suggested asset mix of DFA funds will change automatically without the need for additional input from the investor, who would most likely not know when and what to change–but their managed account does that for them. When should I change my allocation of fixed income from short-term bonds to longer-term bonds? A managed account will do that automatically for the investor. That’s worth something. It may not be worth it to DIY investor who will patiently research the issue and make the move when decide, but it is worth a lot to your average investor. The vast majority of these people paying 1% are not DIY investors grudgingly paying the fee to get access to DFA Funds, they are prudent mom-and-pop investors who want a good return with a lower amount of risk–and doesn’t require them to become experts on investing to do it. They’re not going to craft a portfolio on their own that allows them to achieve the same returns and pocket the reduced fees (most DIY investors would be hard-pressed to do this in actual fact as well). Most likely your average investor would be in a portfolio making far less and taking an extremely low or extremely high amount of risk and running scared from the market or elatedly back into it at the wrong moments. Managed accounts are not unique, and can be a real waste of money in many situations (‘wrap’ accounts with retail mutual funds and no automatic asset allocation changes come to mind), but the ability to combine ownership of DFA funds with automated asset allocation convenience is a real value for most people, and well worth what they pay for it. For most people, not the DIY crowd, managed money with DFA Funds is an incredible opportunity. For the adept DIY crowd, it’s another attractive arrow in their immense quiver.
I agree, except with the part that suggests it is always (or even usually) a good idea to change the asset allocation in response to market conditions. Perhaps the biggest benefit to a managed account is simply that the investor is a little bit less likely to shoot himself in the foot in a down market. Selling low just once late in your career is far worse than paying 1 or even 2% every year for decades.
All that said, it isn’t THAT hard to design a reasonable asset allocation and stick with it. You don’t have to be THAT interested in investing or THAT knowledgeable about it. Assuming 30 years of $50K per year contributions and 8% pre-expense returns, the difference between having a 1% advisory fee and not having it is is over a million dollars (a 21% larger portfolio). Plus, assuming a 4% withdrawal rate, the DIYer gets to spend 33% more in retirement. Seems like an awfully easy way to make a million to me. 🙂
Thanks for the comparison. It just reinforces that you do not need to pay someone to put you into a mixture of index funds. Chances are good that if you are one to panic in a downturn, you will pull out even if you have a manager. In a strong market, many investors have a high risk tolerance. When the market heads south, so does their risk tolerance. That is not what risk tolerance is all about. You say it perfectly. It is not that hard to design a reasonable asset allocation. Sticking with it may be the difficult part. Dalbar’s research has shown that to be the case.
“If DFA funds were available without any advisory relationship which ones would you use?”
This is a very good question yet to be answered…
I’m not at liberty to provide an answer, but it would be a much more interesting conversation than debating advisor fees or historical data, both of which lie somewhere between irrelevant and confusing. You either value advice or you don’t, with value being a very subjective concept, and you either value strategy over outcome or you don’t.
In other words, if you can answer WHY you would use DFA funds (without looking at past performance) and then indicate which specific funds you would use, you’ll gain better insight into this entire discussion of DFA vs. Vanguard or DIY vs. advisor. So fire away.
I do the same thing with cars I’ll likely never buy, which is also a great conversation…
DT
For equity how about this as a starting point DT:
US Core Equity 2 Portfolio (DFTCX) or Vector for more factor tilt 50%
Global Real Estate Securities I (DFGEX) 10%
International Core Equity Portfolio (DFTWX) 30%
DFA World ex US Targeted Val Instl(DWUSX) 10%
First, they are available without an advisory relationship in my 529. I use the small value fund.
Second, while it’s fun to debate what-ifs, it’s not particularly productive. The truth is that if you just want DFA funds, you can get that pretty darn cheap these days. Good advice is getting cheaper and cheaper all the time too.
Thanks White Coat, I was simply restating your question from the main article 🙂 But if you feel that question is not particularly productive, my apologies…
WCI,
Great article. Well researched, and fair analysis.
I also would not pay an advisor for the right to buy DFA funds.
That being said, where DFA really shines is in the small cap value arena, but I don’t see any historical outperformance relative to RZV (Guggenheim small cap value ETF) which is every bit as small and value-ey.
The one area where DFA has cornered the market on a specific tilt is international small cap value. I use DLS for this in my portfolio, but this is an imperfect approximation of the sector and would love to have access to DFA’s fund DISVX, were it open to all investors wothout addotional fee.
Great stuff,
Alexi
This was an interesting read and interesting to read the comments. We have a lot of choices coming up, so we are looking at getting a financial advisor anyway, at least for a financial plan if not AUM. To get access to DFA, we need to have AUM.
I am comfortable with short term liquid funds (“high yield savings” and CDs). I am comfortable with buy and hold retirement portfolios. We currently have IRAs with Vanguard, and, as we join the clinic’s retirement plan, we’ll be building our own with Schwab (any idea how Schwab funds and ETFs compare to Vanguard and DFA?)
It’s the mid-range investments (post-tax brokerage accounts) where I want financial plans/help. How much to put into retirement accounts and lose access, verses how much to do mid-range but be able to get funds at any time? How do the favorable capital gains tax rates compare to higher tax brackets at retirement? What makes the most sense? For these reasons, I am going with a planner to help me on these issues.
Do you have any apple-to-apple thoughts on Scwhab compared to DFA?
Thank you for the comments on Cardiff and Evanson, Paul. I’m actually in contact with Evanson right now because of it. But they have one CFP, the rest are investment advisors. How has Evanson treated you? I see one can pay an hourly fee for financial planning with the CFP. Is their personalization very good? (I’ve had a couple discovery interviews so far, and a couple more… I want to get the best fit possible)
Thanks.
I use a Schwab ETF in my 401(k) (the TIPS one) because its pretty much the same as Vanguards and I don’t have to pay commissions for the Schwab. They’re fine to use in my opinion, just like Fidelity’s.
I figure if I’m going to hire an advisor, I want him to do everything and do all the work. I want my money’s worth out of those AUM fees. Better offer DFA funds to boot.
Well-balanced and fair article, and a good dialogue in the comments. I am faced with managing my wife transition from residency to practice as an ED doc with all of the decisions that it entails, and am very interested in the collective wisdom this forum has to share. Not to mention, it seems as if I also advise more than half her co-residents on financial matters. Much appreciated!
As for Schwab, I have found that their ETFs are extremely competitively priced, with no trading fees. Sometimes lower than Vanguard, and there is enough liquidity to ensure low spreads. My employer’s 401k is run through Schwab, so keeping other funds there means I can get some financial planning advice for free on the majority of my portfolio. For disclosure’s same, I’ve used Schwab funds to tilt my portfolio toward value and small-cap, with a 45% domestic, 35% international, 10% bond, 10% other(REIT, commodities) passive portfolio.
I agree there is little difference between Schwab (and Fidelity) and Vanguard when it comes to index funds NOW. Of course, without Vanguard, I bet those two companies would have never had them. I still slightly prefer the Vanguard funds but I’m not willing to pay large commissions to get them. In my 401(k) (the PCRA option at Schwab) I use both Vanguard and Schwab ETFs.
Curious if anyone has thoughts on this. I’m one of those that probably needs and advisor at this point, so I’ve recently been given an option. I can use a Vanguard advisor that will manage my portfolio for 20 basis points or an advisor with access to DFA funds for 100 BP (that I might be able to get down to 50). Would the access to DFA funds be worth the extra fees? Added wrinkle: in conversation with the Vanguard folks today, it looks like any funds I purchase with them are actually cheaper if my accounts are under their management, so Vanguard funds purchased through the DFA advisor will be more expensive.
You’re choosing between two great options. I think you’re looking for help making a decision assuming “all else being equal” but it’s unlikely that all else is equal with your choices. Given your focus on costs, you might be a good candidate to manage your portfolio on your own, and just pay an hourly adviser for some help with initial set-up and financial planning.
Here’s what Burton Malkiel has to say about the tilting or smart beta strategies offered by many now. This is an excerpt from a lengthy blog he wrote:
“Smart Beta” strategies rely on a type of active management. They are high cost and tax inefficient relative to traditional index funds and none have reliably and consistently beaten the market. As recent research and commentary from Vanguard Group puts it “Smart Beta” strategies are often, “active bets and not substitutes for traditional index funds.”
“Smart Beta” portfolios are more a testament to smart marketing rather than smart investing. We believe that the broad-based low-cost capitalization-weighted index funds that make up the core of the Wealthfront portfolios will give the investor the most prudent trade-off between risk and return available and the most predictable and tax-efficient way to manage and grow your wealth.
A compelling case for Vanguard:
https://dfavsvanguard.wordpress.com/2014/12/14/vanguard-vs-dfa/
I do not think the blog post referenced is interesting but rather just misleading!
When you go to the market, do you compare an Apple to an Orange? They are both fruits. No you would not and you either insult your reader with your comparison or show your lack of knowledge or perhaps your bias.
First some facts. Small cap is more volatile than large cap. Trading small cap is more costly than large cap. Would you agree to these two facts?
If so now look at the funds that you dare to compare.
VTSAX is 72% large, 18% mid and 9% small.
DFVEX is 29% large, 29% mid and 42% small.
As a result of the make up of the two funds you would expect more trading cost and volatility with the fund with more small cap. There is no revelation in the blog as to cost or volitility.
If you want to compare a DFA fund that is more similar, compare the DFA Equity Core DFEOX to the Vanguard Total stock market. Again this is not totally fair since the DFA is 56% large, 28% mid and 17% small but much closer to VTSAX than the DFA Vector.
Over the past 5 years the Vanguard VTSAX lags by 6.3% or about 1.25% a year after expense ratio and corporate structure differences.
I am not sure as to the purpose of this blog since there is only one post but if the first article is an indication I look forward to other misleading posts such as comparing small Vanguard and DFA small cap. Again they are not made up the same:
VSMAX Mid cap 39%, small 50% and Micro 10%
DFSTX Mid 4%, small 66% and 29% Micro
Vanguard and DFA are both good fund families with good low cost offerings to be used within a portfolio based on what the investor wants but please do away with biased and uninformed posts.
I can’t quite tell if you’re referring to my post (on this blog) or the one Alvin linked to. I agree that comparing DFA Equity Core to Vanguard TSM isn’t all that similar. the DFA fund is smaller, and I believe, more valuey.
My 2 cents about that blog.
Consider the following…All investors have 3 primary variables to select from when trading – time, quantity, and price. No investor can prioritize all 3, they must choose 2 of the 3. An index fund manager, for example, must prioritize quantity and time in order to avoid tracking error to the index. They will sacrifice price (paying the ask price or “retail” price when buying a stock for example) in order to get a trade completed under urgent quantity and time demands. A fund manager such as DFA, however, prioritizes price paid (buying at the bid price or “wholesale” price from urgent sellers) and then chooses to sacrifice quantity or time. They are willing to sacrifice modest tracking error to indexes in order to achieve superior trade execution. So if the goal is to match an index return, we use funds that track indexes and accept the hidden cost of the fund manager’s propensity to sacrifice the spread between the bid and ask prices when trading. If the goal is to target risk factor exposures over tracking indexes, we use passive funds that don’t track indexes.
IMO, DFA has a superior approach to trade execution while Vanguard has a superior approach to managing explicit fund costs. For DFA to outperform Vanguard for a given asset class is at least partially driven by their ability to consistently “capture the spread” when trading at a net cost lower than Vanguard’s approach.
If we look at correct comparisons based on risk factor regressions, instead of an apples to oranges comparisons, we see that DFA’s advantage is nearly a 1 to 1 relationship with the average bid/ask spread in that asset class universe…
Comparing DFVEX to VTSAX is incredibly misleading and serves as a clear example of using outcome over process to define strategy, and that’s a recipe for mediocrity.
To do this somewhat correctly, you need to compare a 35/65 VTSAX/VSIAX mix with DFVEX. You would then be comparing a roughly 0.4/.04 size/value risk factor loading embedded in each instead of a 0.00/0.00 factor loading vs. 0.4/0.4.
There are other deciding factors of course, but hopefully this adds transparency to this discussion…
Thanks,
DT
I agree that would be a more appropriate comparison.
Thanks for posting this. My 401k interestingly only has one international fund in the entire mix and only one DFA fund, which happens to be DFA international small value.
I’ve been 100% Vanguard Target 2045 in my 401k but tilt with Vanguard SCV in my Roth–though with not international small/value tilts. With no DFA advisor fees in my 401k, I think the DISVX 0.68% ER–the highest in my portfolio–may be worth it. I still keep everything under the Vanguard umbrella, as well, as they manage our 401k.
Interesting 401(k). I’d definitely consider using that fund, even at that price.
Let’s see, if we set aside all the value that a good advisor provides (education, a goals-based allocation, planning, discipline) a just look at asset class selection, there appears to be significant long-term value to using more focused asset class strategies. We have live-fund data on Vanguard funds as far back as 5/1998. Through August, here is what I see:
Vanguard Value Index = +159%
DFA U Large Value = +239%
Vanguard Small Value Index = +308%
DFA U Small Value = +376%
Vanguard Int’l Value = +145%
DFA Int’l Value = +175%
DFA Int’l Small Value = +404%
As for US “large market” exposure, from 1998-2014, t DFA US Large Cap Equity Index beat the S&P 500 by 1.3% annually – +7.8% annually vs +6.5%.
I don’t see any evidence that Vanguard is all that close in reproducing the asset class results of DFA. That being said, the value of the services I didn’t expand upon above are still much greater than the DFA advantages clearly seen from the data.
Technically, part of those higher returns (which I haven’t confirmed and am just taking at face value, and also obviously may be partially due to the period of time examined) is from taking on additional risk. The DFA funds are generally smaller and more valuey than the Vanguard funds. So, higher returns but also higher risk.
Correct, the higher return exhibited by DFA over that time frame is primarily attributable to deeper factor exposure, and secondarily to trade execution. On factor exposure, for example, running DFA Large Value and Vanguard Value through the factor analysis on portfoliovisualizer.com (one of several sources for this info), we see that DFA’s recent value factor is nearly double that of Vanguard’s at .62 and .34 respectively. So it makes perfect sense that during a period when the value premium is positive, we see DFA dominance. As for trade execution, Vanguard and other index tracking funds, being sensitive to tracking error, must prioritize the quantity and timing of the trade over the price of the trade. In other words, index tracking funds tend to buy at the retail price and sell at the wholesale price, giving up the bid/ask spread as the price paid to avoid tracking error. That’s a hidden cost of index tracking that ultimately shows up in numbers like Eric’s above. DFA, not being focused on tracking error, prioritizes price paid (buy wholesale, sell retail) and leaves quantity or time as the variable to sacrifice on any given trade. And since DFA is focused on the risk characteristic, not necessarily a specific stock, they can substitute one stock for another if it helps them maintain their position as a liquidity provider to more urgent traders in the marketplace.
So part of the story is higher risk (higher factor exposure), but don’t discount the trade execution part of the equation.
No doubt. And of course you must factor in the fact that DFA wishes to make a profit. 🙂 Which may very cancel out the benefits of both execution and a higher factor exposure. Pluses and minuses both ways.
Interestingly, I have a bit of an ongoing experiment in real time pitting DFA and Vanguard directly against each other. The Utah 529 plan has both DFA small value and Vanguard small value, but won’t allow you to put more than 25% of the portfolio into either one. So I’ve got precisely 25% in each of them so it is easy to see which is doing better. It’s only been a year and a half but so far Vanguard is way ahead. Blame it on whatever you want, only returns pay tuition.