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Why DFA Outperforms Vanguard

Image Source: DFA When investors start to consider funds that fit their portfolio they usually turn to one of the big ETF providers. It depends on the individual’s portfolio, but Vanguard is often a great choice. They offer the widest selection of US equity ETF’s, they are low cost and have a great history of tracking the respective indexes. However, a lesser known fund provider has consistently outperformed others, including Vanguard.

Dimensional Fund Advisors has the best client loyalty ratings in the world. It’s not hard to see why. Aside from their performance, they don’t pay commissions to advisors that use their products. Also they are a very picky firm. Financial advisors who want the privilege to use DFA index funds to build portfolios must undergo heavy scrutiny. In fact, most have to fly to DFA headquarters in the United States to go through extra training. Dimensional Fund Advisors (DFA) implements a strategy that is designed to capture the risk factors that explain 96% of stock market returns.

Academic research has shown that over long investment periods, the following six characteristics consistently show up in the data going back to 1926:

  • Market: Equity offers higher returns than fixed income

  • Company Size: Small-cap companies offer higher equity returns than large-cap companies

  • Relative Price: Value companies offer higher equity returns than growth companies

  • Profitability: High profitability companies offer higher equity returns than low profitability companies

  • Term: Longer term bonds offer higher returns than short term bonds

  • Credit: Bonds with lower credit rating offer higher returns than bonds with high ratings on a risk-adjusted level

With these 6 dimensions, DFA have implemented these academic insights into turn-key low-cost solutions to build well diversified portfolios to capture these six long term dimensions of expected returns.

Dimensional Fund Advisors is part of a second generation index fund group which the financial industry likes to refer to as "smart index funds". DFA provides tilts towards value and small cap funds as well as the other four dimensions mentioned above.[1] On top of this strategy, Dimensional Fund Advisors do one thing that almost no other advisor or fund house does. In a bear market when everyone is selling and taking their money out of equity, DFA encourages their clients to stay invested and rebalance their portfolio, thereby capturing the returns when the market recovers subsequently. DFA does this by mandating that all their advisors undergo rigorous academic training, both in the above mentioned 6 dimensions and, more importantly, in the insights of behavioral economics. In the crisis of 2008, DFA was the only fund house in the world with net cash inflows while Vanguard and other ETF providers faced net cash outflows. It is through their strategy, successful implementation and the mandate of rigorous academic training of their advisers that DFA has performed better than other fund providers.

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