Nun,
I think DFA vs do-it-yourself index funds deserves lot more research rather than just tossing it away. I have done a bit of research and it looks DFA might be slightly better. Please hear me out ...Just do a DFA vs Vanguard in google and there are some very interesting posts with data and facts. Of course people will be quick to point out that past performance is not indicative of future results but that is true with everything. Maybe cash will outperform stocks and bonds over next 50 years. So lets keep that caveats aside and look at (mostly) past data. I will also try to give some causal reasons below. I dont own any DFA funds but I am intrigued.
Many notable fee-only financial planners , including those who post on bogleheads seem to like DFA. Of course we can be skeptical and quickly dismiss it as : "They stand to gain the 1% fee so its just self interest". Maybe thats true, but there is more to it. Please read on ...
Suppose you want exposure to equities : The issue comes down to whether you want to keep a simple "total stock market index fund" vs "slice and dice". I tried to raise this in my asset allocation paralysis thread on bogleheads and also in my "getting equities right" bogleheads thread and most people opined that "it doesnt matter" or and "your stocks/bonds AA is the most important". But just ignoring things which seem complicated to us is not the scientific thing to do. Based on the research I am doing, it appears that slice-and-dice may provide better returns.
Perhaps over a 50 year period, it wont matter and VFINX(S&P 500) or VTSMX(Total stock market) might have the same return as slice/dice, but most investors' time horizons are about 25 years or so, during which a slice-n-dice may offer less risk and possibly higher return.
Have you read Paul Merriman's Ultimate Buy and hold article ? You can read it at
FundAdvice.com - Home. It is well written and makes a lot sense. Statistics and finance theory proves that slice and dice is most likely better than owning the whole lot, assuming you can stick to the AA discipline. This is simply because if you have a bunch of uncorelated assets, you can slightly minimize the risk and get slightly better return. Take the Vanguard Total Stock Market Fund, this is mostly large-cap. It has got only 9% or so in small-cap. In this article :
Slice and dice or TSM? My Message, Rick Ferri has clearly shown that slice-and-dice is mathematically better provided you can stick to the asset allocation. See also :
FundAdvice.com - Where's the "Total" in the Total Stock Market Fund?. Now you may argue that it is hard to find uncorelated assets, and you may have a point, but if you split your portfolio as Large/Small-Cap Growth/Value (2x2) and do the same for International and do the same for emerging, you WILL end up with a few uncorrelated asset classes and that will be to your advantage.
So once you decide that slice and dice is what you want, then the question is : Who provides index funds for every single asset class you can think of ? DFA does and Vanguard does not. In
FundAdvice.com - The best mutual funds: DFA or Vanguard?, Vanguard's international small-cap fund is closed to new investors and Vanguard does not have an International Small Cap Value fund. so you are not getting exposure to these asset classes.
Paul Merriman's article above as well as
http://www.econ.duke.edu/Papers/PDF/Vanguard_Versus_DFA_30 july_2007.pdf Masters thesis shows that DFA outperforms Vanguard by about 2 to 3 percentage points simply because of their precise asset allocation.
DFA funds are NOT like actively managed funds doing day trading and creating huge turnover costs and trying to outperform the market. Nobody here is trying outperform the market. DFA is the brain child of Eugene Fama, Prrofessor Extraordinaire at Univ of Chicago, the father of modern portfolio theory which holds that you cant beat the market so caputure the whole market. So it is the same idea as index funds, but done in a more precise way to capture every single asset class you can get. Also, index funds slavishly follow the index, and if made available to every Tom Dick and Harry who wants to "get out of the market" on a whim which will cause huge turnover. This is why DFA dont advertise and provide access to every day trader out there. This should result in low turnover.
Having said that the question is whether it is worth paying the 1% fee that many advisors charge. I am in Europe and it looks like the fees may be higher here, especially for smaller portfolios and I am not so sure if it is worth paying 2%. But Americans always get good prices and at 1% I would be tempted. Of course if Vanguard offered index funds in the 2 asset classes I pointed out above, I might stick with Vanguard and use Paul Merriman's ultimate buy and hold portfolio.
Since I myself have not yet decided whether to use low cost ETFs/Vanguard or pay for DFA, I would be willing to explore this further with anyone interested.
If you have a large amount of money to invest the DFA advisory fees seem to come down even more, and at that point (0.5% of assets) it seems to add value.
Lest I forget - pssst Wellesley! A little investing humor.
