As I discussed in a previous article, Dimensional and Vanguard are similar but are different in some key respects. While neither fund family relies on forecasting or individual security analysis, Vanguard funds are index funds while Dimensional funds are not.
Both fund families are great options for investors. However, Dimensional provides several advantages that may result in better outcomes for investors, including:
- Portfolio structure and design. Index funds are forced to weight their portfolios according to the weights of the index it is tracking, and indexes are generally market “cap” weighted. But what if market cap weighting is not the optimal way to invest? Dimensional begins with a market cap weight and then tilts their portfolios toward various risk and return factors such as size, value, and profitability in an effort to capture higher returns.
- Portfolio cohesion. With Dimensional, it is easier to build and maintain a cohesive portfolio that provides broad diversification with no overlap, redundancy or gaps. This means lower transaction costs, more tax efficiency, and more manageable portfolios. Furthermore, Dimensional’s broadly diversified “core” funds allow a stock to migrate across style categories without being sold and repurchased, minimizing turnover, trading costs and taxes.
- More stable fund flows and no excessive trading. With any mutual fund, some of the investors may engage in active trading in and out of the fund. But this type of trading drives up transaction costs and taxes for all of the fund’s investors, even buy and hold investors. Because Dimensional funds are not open to the public, Dimensional is able to limit the amount of trading in their funds without restricting redemptions. Even during the rocky 2008-2012 period, Dimensional experienced positive inflows into their equity funds. When the market was in fire sale mode, they were patiently buying.
- Trading Advantages. Because Dimensional funds are not strictly tied to an index, the portfolio managers can be flexible and patient when it comes to trading. For example, many index funds are forced to pay a premium for stocks being added to an index and sell at a discount when a stock is being removed from an index. Dimensional avoids this “reconstitution” cost, which is especially important in small and micro-cap stocks.
Because of these and other advantages, I believe that the odds are that a portfolio using Dimensional funds will do better than a similar portfolio of Vanguard funds over an extended period of time. How much better? It’s hard to tell, but it’s almost certainly less than 1%. That may not seem like a lot, but when you combine what could be a 30 or 40 basis point advantage per year with lower taxes, the advantages can have a real impact on investor outcomes.
So has Dimensional delivered? That is the subject of the next article in this series.