In our last post introducing Dimensional Fund Advisors, we provided a brief, hopefully mildly entertaining history on the ongoing efforts to connect market theory with practical investing. Dimensional Fund Advisors has been integral to many of those efforts. In this post, we’ll explore how Dimensional and others have been bringing the science of investing to the people – at least those who are willing to heed the evidence.
Evidence-Based Investing by Any Other Name
For lack of a better term, those who justifiably turned away from active investing ended up being thought of as passive investors, i.e., the opposite of active investors. Personally, we prefer the term “evidence-based investing” as more descriptive.
Rather than trying to chase a wily market or pick future individual winners or losers, evidence-based (passive) fund managers like Dimensional, Vanguard and others seek to build funds that efficiently capture the returns available from broad risk factors or “asset classes” within the market. Their funds are structured to target various asset classes, affording several advantages over actively managed funds:
(1) Personalized planning – It enables you, the individual investor, to build a portfolio that best reflects your own personal goals and risk tolerances, reliably tilting away from or toward asset-class funds characterized as riskier (with higher expected returns) or safer/smoother (with lower expected returns).
(2) Disciplined investing – It reduces guesswork, which makes it easier (albeit not easy) to more patiently stay the course when markets head south. To paraphrase Winston Churchill, when you’re going through hell, it helps you to keep going.
(3) Cost management – It offers numerous ways to reduce the debilitating cost of investing.
Dimensional Fund Advisors: The Passive Strategy That Isn’t
As we touched on above, Dimensional is not the only fund family that has turned away from active management. But from its inception, this fund manager has carved out a name for itself as a leader among evidence-based investment management. In fact, call them “passive” to their face and you may receive an active punch in the nose, or at least a pained grimace in return.
Most other passively managed mutual funds are index funds that track a standard index, which in turn, tracks a particular asset class. For example, the S&P 500 Index reports on returns among large-company stocks by tracking 500 representative companies from the entire group. The Vanguard 500 Index Fund invests in those 500 sample companies. This provides you, the investor, with relatively reliable exposure to the U.S. large-cap asset class.
So far so good, but then Dimensional goes one better by eliminating the middle man and directly tracking the asset class itself instead of the index that approximates it. Here is a handy chart that summarizes the value added in this distinct approach:
Thus, Dimensional isn’t “active” in the classic sense, nor are they passive index fund managers either. They’re Dimensional.
No Laurel-Resting Here
The Dimensional distinction is not merely in the past tense. Beyond tracking traditional asset classes now in common use among passively managed funds, the fund manager continues to collaborate with the academic community, exploring how to efficiently incorporate less-familiar but demonstrated dimensions of return into their funds to enhance investors’ expected returns. Two current examples include the profitability and momentum factors.
But we digress. Suffice it to say the Dimensional team members are financial nerds after our own heart. If you’d like to learn more, please give us a call and we’d be delighted to blather on and on about it. If you haven’t noticed, we totally get into this sort of stuff – for ourselves as well as on behalf of our investor clients.
For more information or to set up a consultation, contact Pathway Financial Planning at 248-567-2160 or email email@example.com.