Dimensional funds DFA performance
James Sweeney No Comments

If your financial advisor uses Dimensional Fund Advisor (DFA) funds, odds are you’ve been underperforming the broad market for a while.

That’s not comfortable. Even a patient investor may be wondering whether Dimensional and/or their financial advisor have lost their mojo.

Whether you’re invested in DFA funds or any other investment, there are several reasons any given portfolio may underperform relative to others. Some of those reasons may justify throwing in the towel. Others are just part of investing.

From that perspective, let’s consider when you should, and should not reconsider your investment advisor and/or investment strategy.

I. When to stay…

Most sources of expected return require investors to tolerate setbacks along the road to long-term outperformance. No pain, no expected gain.

Frankly, when you’re in the middle of a setback, it’s impossible to know for sure what you’re seeing. We do know every investment factor has its “turns” at both the top and bottom of the pile. The downturns can sometimes be long and severe. Until you’re viewing the results in hindsight, it’s hard to know whether the factor is in a temporary lull, or a permanent demise.

Instead of trying to peer into a foggy future, I recommend being guided by clear strategy, based on the best available evidence on how markets have delivered long-term returns. This still doesn’t guarantee you’ll earn the returns you’re hoping for, but it’s the best way I know to tilt the very challenging odds in your favor.

Practically speaking, what does that mean?

Stay Globally Diversified

For the past 10 years, U.S. stocks have considerably outpaced their international counterparts. But decades of evidence inform us: Domestic and international stocks have each had their relative periods of booms and busts. Equally as important, there’s rarely a clear sign telling us when the tables are about to turn.

For example, these days, the U.S. market has been besting international stocks for a while. Dimensional reports, from 2010–2019, the S&P 500 delivered 13.56% annualized returns while many international markets have lagged behind.

This may have tempted some investors to load up on U.S. stocks. Before you become one of them, remember the 1990s and beyond. During the tech boom, many investors felt the same way. But when that bubble burst in the new millennium, those same investors regretted their concentrated positions. During the subsequent S&P 500 “lost decade,” the S&P 500 was down an annualized –0.95%.

The best course is to stay globally diversified throughout. Together, U.S. and international positions have delivered satisfactory returns over time and across ever-shifting global events.

For example, as Dimensional presented in its year-end 2020 report:

“Over the past 20 years … investing outside the US presented investors with opportunities to capture annualized returns that surpassed the S&P 500’s 6.06%, despite periods of underperformance, including the most recent decade.”

Stay Value Oriented

Likewise, value stocks have underperformed relative to growth stocks over the past decade-plus, and particularly over the last few years. So too have DFA portfolios that typically emphasize value over growth.

Are value stocks dead, as some have suggested? Or, as Dimensional’s David Booth has proposed, are they “crouching lower now so they can spring up higher later”?

We’re sticking with the tiger theory, as evidence is strong that value’s long tail is still twitching. To cite one compelling argument, many investors may not realize the value premium has actually remained about average relative to past performance. As Booth reports, “According to Dimensional’s research, while value’s performance in the US from 2009–2019 was in line with its historical average (12.9% vs. 12.7%), growth significantly exceeded its historical average (16.3% vs. 9.7%).”

In other words, it’s not that value stocks have stopped delivering during the past decade. It’s that growth has been on a relative growth spurt (no pun intended).

The same principles apply here as for domestic vs. international investing: (1) growth spurts don’t last forever, and (2) there’s rarely any warning when fortunes are about to change. So, here too, don’t abandon value stocks based solely on recent performance.

II. When to go…

If even a decade of underperforming the broad market doesn’t mean you should alter course, when is a good time to rethink your position? Here are a couple of legitimate red flags I’ve seen from investors who are considering a fresh start.

Let Go of Unnecessary Complication

Whether you’re invested in DFA or any other fund family, if your list of holdings is longer than your weekly grocery list, you could probably benefit by simplifying your portfolio.

These days, a handful of low-cost, tax-efficient, globally diversified funds can give you efficient exposure to the expected market returns you’d like to capture. Piling you into anything more than a handful of funds may be the sign of an advisor who is trying to justify their fee by making investing seem more complicated than it is.

Too many holdings can hinder your progress through:

  • Increased trading turnover, with more trading costs and higher taxes
  • Higher fund expenses
  • Added complexity that flies in the face of sound investing principles such as transparency, discipline, and optimized market efficiency.
  • More personal stress and confusion trying to understand what you own

Let Go of Excessive Advisor Fees

If your advisor is failing to add enough value to warrant the amount you’re paying them, it might be time to shop around. We advisors do need to charge for our services. But what’s a fair price?

Typically, I see advisors charging fees of 0.6%–1.5% annually, based on assets under management (AUM) – with smaller portfolios typically paying toward the higher end of that range and larger portfolios paying toward the lower end. In practice what this means is that if your portfolio is over $1M, you are likely paying $10,000 or more every year in advisory fees. That’s a lot of money. If you are paying that much simply for the privilege of gaining access to DFA funds, you are likely to be disappointed.

So how can you benefit from an advisor who follows this evidence-based, efficient investing approach? Simple. Look for an advisor who either charges less than 1% to manage your assets, adds measurable value in other ways, or better yet, does BOTH.

If your advisor is strictly a portfolio manager, I believe your fee really shouldn’t exceed 0.25%, especially if your portfolio is $1 million or more. Despite the fact that there are many places you can find this streamlined and low-cost service, many advisors still manage to charge the standard 1% for little more than occasional portfolio rebalances, quarterly reports and a couple of phone calls a year. This is a travesty.

Is your advisor also providing ongoing guidance on your greater financial life? Are they helping you identify and organize your retirement plans, tax strategies, insurance coverage, estate planning, charitable giving, college funding, business successions, etc.? If so, this level of service warrants additional compensation.

However, these services typically don’t vary based on the size of your portfolio. That’s why I’ve long felt the AUM fee model isn’t optimal – at least not for you, the client.

Instead, we charge a flat annual fee for both portfolio management and financial planning. That way, it’s easier to see upfront exactly what you’re paying for the services you’re receiving. Makes sense, doesn’t it?

Should You Stay or Should You Go?

I hope I’ve provided food for thought on how to think about and analyze the performance of your accounts, especially for those who have engaged an advisor to manage their DFA investments.

We’ll part by some words of wisdom from the late, great Vanguard founder Jack Bogle:

“Successful short-term marketing strategies are rarely, if ever, successful long-term investment strategies.”

Even with a sensible strategy in place, it’s not unusual to have some doubts when your portfolio isn’t comparing favorably to others. But if it’s optimally invested according to your plan – and that plan remains relevant to your personal financial goals – you’re usually best off staying the course. Plans and portfolios usually need ample time to unfold as hoped for.

On the other hand, if your investments have become overly complicated or your advisor’s fees are excessive for the services provided, it may be time to think about making a change.

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