Dimensional Fund Advisors Funds (DFA Funds): Better Than Vanguard?
Vanguard has long been my favorite of the major mutual fund companies (particularly for their dirt-cheap index funds), but it’s not the only game in town. There are a number of smaller boutique fund companies nipping at Vanguard’s heels, Dimensional Fund Advisors (DFA) chief among them. Dimensional Fund Advisors (DFA) takes Vanguard’s business model of providing low-cost index funds a step further by offering index funds in a variety of asset classes (such as domestic micro-cap and emerging market small value stocks) not available at Vanguard (or anywhere else, for that matter).
Should you buy Dimensional Fund Advisors (DFA) Funds over Vanguard?
About Dimensional Fund Advisors (DFA)
Dimensional Fund Advisor’s business model is unique in that they don’t allow just anyone to buy their funds. They only sell through fee-only certified financial planners, and even then only through planners they deem worthy. The theory is that by excluding investors most likely to trade in and out frequently (small, DIY investors), DFA funds will be able to better manage their cash flows, which has the effect of lowering trading costs and improving tax efficiency for all investors. So far, it seems to have worked.
Dimensional Fund Advisors has been around for almost 30 years now, even though they have only began to catch the attention the DIY investors community recently. DFA funds have proven to have solid long-term track records both on an absolute basis and relative to their competition at Vanguard. To compare the performance and investment characteristics of any given DFA fund and its Vanguard equivalent, I recommend signing up for a free Morningstar account.
DFA Funds vs Vanguard Funds
While Vanguard still has a cost advantage in almost every segment in which they compete with DFA funds, the cost differential has been narrowing of late. Furthermore, Vanguard doesn’t offer index funds for a number of important asset classes most slice-and-dice investors would love to get their hands on, most notably international small value, emerging market small value, and U.S. micro caps. DFA funds really are the only decent choices for these oft-ignored asset classes, which unfortunately presents a problem for DIYers due to the reasons above.
Should You Buy DFA Funds?
This is somewhat of a trick question. The answer is that yes, I think it is wise to buy DFA funds in asset classes for which there is no lower-cost Vanguard equivalent, provided of course that you are already working with a financial planner with access to DFA funds. For the DIY slice-and-dicer, I don’t think it makes sense to pay a financial planner just for the privilege of owning a few exotic asset classes, no matter how great they are.
Even if you have access to DFA funds, I think it makes sense to stick with Vanguard funds whenever possible due to their somewhat lower expense ratios and use DFA funds to fill out your asset allocation. Personally, I’ll be sticking with 100% Vanguard funds merely because I don’t currently work with a financial planner and don’t plan on hiring one anytime soon (well, maybe if I won the lottery…). In the end, you have to decide if the additional diversification benefit Dimensional Fund Advisors provides is worth the added hassle and expense of working with a planner. For many people, it is 100% worth it. For others, like me, it isn’t.
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Thanks for bringing this up. There are in fact ETF options in the “exotic” fund classes you mention. For example, from WisdomTree for international small cap value there is DLS, and for emerging small cap value one can use DGS.
You refer us to Morningstar, but would you care to show some sample performance comparisons? Any idea why the performance gap between Vanguard and DFA is narrowing, if in fact it is? Also, who is the cheapest financial advisor to offer DFA?
DLS and DGS are both good funds with reasonable expenses, but I’d consider them more mid-cap than small-cap. The DFA small-cap funds focus on CSRP8-10 whereas the Wisdomtree ETFs carry an average market cap around $1 billion or so, according to Morningstar. Not bad, but I would really prefer something smaller. That said, Vanguard’s own international small-cap index fund’s median market cap is a hefty $1.2 billion.
As for why the performance gap is narrowing, it’s most likely due to DFA closing the cost gap. Lower expenses = better performance in the index fund world. As far as the cheapest DFA advisor, I have no idea. But Rick Ferri comes highly recommended (portfoliosolutions.com). I don’t know if he works with long-distance clients but I would imagine he does.
By the way, big fan LDC. I’ve made use of many an LDC corpus in my day.
There are several DFA advisors out there that offer below market fees, but weigh the advise and attention that you might get from these discounters.
Consider, will they harvest your losses or consider your year-to-year tax situation? Do you get a “canned” investment model or a customized one? How often do they call you, and how available are they if you want to call them?
If fees are your absolute concern above all else, and you don’t care about service or other factors that go into a successful advisory relationship, skip the whole thing and buy ETFs or index funds on your own and save the money.
With DFA, I am only seeking access to DFA funds, not investment advice. Even though DFA advisors are most likely trustworthy, I value doing it yourself and self-education. I feel confident harvesting my own losses, rebalancing, managing my tax strategy, and staying invested for the long haul through choppy waters. I do this with ETFs now. It’s just the buzz surrounding DFA (and their track record) that keeps me curious. Perhaps we will see future ETF releases that will make DFA less useful.
Specifically, it would be nice to have other ETF options other than DGS and DLS from WisdomTree.
Kyle, cool you are familiar with the LDC.
See page two of this report: http://www.ifa.com/Media/Images/PDF%20files/Morningstar-IndexingGoesHollywood.pdf .
It suggests that DFA advisors are 109% successful at capturing the DFA fund returns, while DIYers are only 82% successful. I am a DFA advisor and it is nice to see an independent analysis of our value added. According to this report, our fees are covered by our excess Dollar Weighted Returns alone and all our other services would be included.
The study states, “Consider the success Dimensional Fund Advisors (DFA) has had in selling its funds through advisors who undergo training on the merits of passive investing and in portfolio construction theory. Consider that over the past decade the dollar-weighted return of all index funds was just 82% of the time-weighted return investors could have gotten with those funds. Yet, the figures for DFA are much better. In fact, the dollar-weighted returns of DFA funds over the past 10 years are actually higher than their time-weighted returns. Suggesting advisors who use DFA encourage very smart behavior among their clients, even buying more out-of-favor segments of the market and riding them up, rather than buying at the peak and riding the trend down, which is usually the case with fund investors.”
Steve,
I am a DFA advisor as well. However, let me say this, some DFA advisors use the fund to hold their clients captive. Overall, advisors do not add as much value as they think they do. Don’t get me wrong, DFA advisors (including Mark) are better than 90% of financial advisors out there, since we are fee-only, which removes conflict of interest and we have to go through pretty rigorous training in modern finance. (Unlike other financial advisors, who go through rigorous training in sales and marketing.) That said, DFA advisors are not without self-interest.
The biggest value of an advisor is to help anchor your investment decision on a rigorous process. The investment decision process is much more important than access to DFA funds. If you can accomplish that yourself, you don’t need an advisor.
Michael Zhuang
http://www.investment-fiduciary.com
Michael, Great comments. Let me first say that Adam Smith identified the common value of self-interest to all parties way back in 1776. It is a good thing. All capitalists are in business to serve their self-interest, otherwise capitalism would not work better than socialism. I suspect as a DFA advisor, you are also in business to serve your self interest. Ironically, we used to call our firm St. Index Funds, because for several years in the early days of IFA, all I did was write checks to keep IFA doors open. However, despite my desire to help investors all over the world understand the benefits of passive investing, I primarily invested in the business because I believed it to be a good investment.
As to your point about anchoring the investment decision to a rigorous process, I agree. However, the evidence from Morningstar indicates that non-DFA indexers only captured 82% of index fund returns, while DFA fund investors (which are guided by an advisor) captured 109% of the fund returns, through higher dollar weighted returns. Please note that is the average dollar weighted return before fees, due to variance in advice and fees, some DFA advisors to better and some do worse. That is a whopping 27% difference. So the genius of DFA’s strategy to only offer their funds through advisors has been validated in at least one independent study. Discipline plus great investments had a 27% synergistic benefit. So, according to the Morningstar article, the odds are clearly against somebody doing this on their own and getting the same result. With $1 Billion in assets under management, about 1,800 clients, and 10 years under my belt, I always felt we were adding significant value to the investment process. It is great to see that somebody else came to the same conclusion. Thanks, Mark
Mark,
Your point is well taken. By the way, it blows my mind that you have 1800 clients. I my wildest dream, I want to help 100 families accomplish that that are important to them. I only have 30 some clients now and I are already quite pressed for time. I am scaling back my vision to 60 wealth management clients so quality won’t suffer.
For experienced investors like Steve, I’d like to make low cost access to DFA funds available to them: http://dfadiy.com. They won’t get the same services as my wealth management clients though.
Michael Zhuang
I forgot to ask a favor of visitors to this blog. The “DFA for DIY investors” service is still in beta. Tell me what you think. If it is a bad idea, I can still stop it from rolling out.
Michael
Kyle,
You have certainly creating an interesting topic about access to DFA Funds versus Index funds and ETFs. It is a good discussion on proper use through an advisor or via the DIY route.
Years ago, I was fortunate enough to take some of my DFA classes at the Dimensional HQ when Mark Hebner was in attendance (Hello, Mark). As in the past, his thoughts are always well-received and well thought-out.
Along with the article Mark referenced, numerous other studies have asserted that clients who work with an advisor do seem to be able to capture a larger percentage of the available returns. Could this be due to the fact that the advisor is able to pull the emotional aspect out of the investment piece?
But as Michael so wisely pointed out, not all advisors are made from the same substance. Some offer planning services in conjunction with their investment management. Others do have a more rigid (some may call it “canned”) approach, which may not be a bad thing – it certainly formalizes their a consistent approach to investing and exposure to all asset classes. Isn’t that the goal that most investors are seeking?
A DIY approach can be great, but the idea of cheap may be misleading. Is the investor’s time considered into this equation? Is the investor able to stay on top of the process on their own?
When you invest yourself, be it in DFA Funds, Vanguard, etc. you must have the emotional acumen and personal discipline to follow the process, which, as Michael pointed out is the key element.
If the investor is not capturing the return due to behavior that results from emotion, and the advisor is able to remove the emotion and increase the return, then wouldn’t it be also possible to consider a DIY approach expensive from that vantage point?
Unless I’m missing the point, if it seems logical to the investor that an advisor may potentially increase their return by at least the cost of their fee, save them more than the cost of the fee in behavioral mistakes that could be avoided, and save them time, effort, and worry…then doesn’t that seem cheap?
Cheers,
Matt
PS…In full disclosure – we are also a Fee-Only firm that offers fixed fee, low-cost access to DFA funds.
I like the idea of canned portfolios of DFA funds. I have looked at a number of them and decided to go with #12 at AssetBuilder.com. They do not give much personal advice, except in the discussion forums at their web site. But if I need personal advice I can get 3 hours worth annually from Ernst & Young inexpensively as a benefit through my employer. Picking a canned portfolio is like picking a funds-within-a-fund mutual fund. But I am by far happier with this portfolio’s risk to reward ratio than any funds-with-a-fund I can find. When I build my own portfolio at Vanguard I was constantly fiddling with it. I cannot do that with my DFA portfolio and I glad to be without that temptation.
Roger
Matt,
Very thoughtful comment you wrote.
There is overwhelmingly evidence that investors everywhere have a tendency to hurt themselves. What is not clear is that a generalist portfolio manager can counter that tendency enough to justify charging for >1% of AUM. By “generalist portfolio manager” I mean managers who help with asset allocation, fund selection and portfolio monitoring. I started with the approach only to find out that clients won’t listening to your advice when it matters the most. I have since adopted a personal CFO approach; I spent considerable amount of time getting to know my small number of clients, build trust, strengthen relationship. I have found my advices are taken much more seriously and I am finally able to add substantial value to my clients’ lives, and not just in investment.
I have also learned, the generalist portfolio manager approach is scalable, one can have thousands of clients, but the personal CFO approach is NOT scalable at all. Getting to know clients and building trust with them are not only time-consuming, but also un-delegate-able. So as a business model, this maybe be ideal for those advisors who bent on getting real big, but it is ideal for advisors who enter the business because they enjoy helping people.