A Better Portfolio

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While we don’t use Dimensional Funds exclusively, we do believe wholeheartedly in their approach to investment management. Why? Because no other company has done a better job of discovering and capturing the various dimensions of return that the stock and bond markets have to offer.

What are those dimensions of returns (aka “risk factors”)? In a nutshell, there are six of them and, taken together, they account for the vast majority of any well-diversified portfolio’s returns:

dimensions

In other words: stocks have higher expected returns than bonds, value stocks have higher expected returns than growth stocks, small cap stocks have higher expected returns than large cap stocks, and the stocks of companies with high relative profitability have higher expected returns than the stocks of companies with low relative profitability.

fourcornersConsider, for example, the S&P 500 – a widely cited index of the largest U.S. companies (by capitalization).  From 1927 through 2012, the S&P 500 index returned 9.8% annually, on average. During that same time period, however, the large-cap value index returned 11.6% and the large-cap growth index returned just 9.2%.

Similarly, during the same time period, small cap stocks returned 11.5% annually, on average; small value stocks, however, returned 14.8% while small growth stocks returned just 8.7%.

With this knowledge at hand, DFA set out to develop a group of low-cost funds designed to capture these various dimensions of return.  And their historical track-record speaks for itself – few, if any, fund managers can claim two- to three-decades of consistently delivering what they promise to deliver.

dfa-track-record

Combined appropriately, the various “dimensions of return” have delivered wonderful results. For example, from 1973 through 2012 the S&P 500 earned approximately 9.8% per year, on average (with a “standard deviation” – a measure of risk – of about 18%).  Not bad, until you consider what a dimensional-style portfolio might have accomplished over that same time period:

Stats

Importantly, note that even a well-balanced portfolio comprised of 60% stocks and 40% bonds, earned greater returns than the S&P 500 alone and did so with almost 1/2 the risk! Is that likely to occur again in the future? Probably not, unfortunately, given the once-in-a-lifetime bull market in bonds that we experienced over the past couple of decades. But even the all-equity portfolio provided a substantial increase in returns (versus the S&P 500), with considerably less risk.

Click here for more information about Dimensional Funds.