DFA Mutual Funds Explained
Dimensional Fund Advisors, is an investment management company that takes a unique approach to the mutual fund investment strategy.
As with traditional mutual funds, DFA allows investors the opportunity to pool their funds with other investors to buy blocks of securities, but the strategy behind selecting assets for a DFA mutual funds differs significantly.
The techniques used to select assets are guided through academic research that follows the science of investing rather than simply making predictions based on past market performance or the success or failure of certain companies.
Dimensional Investment Philosophy: Utilizing Academic Research and Empirical Evidence
Dimensional Fund Advisors (DFA) was founded by David G. Booth and Rex Sinquefield in 1981. David Booth, a professor at the University of Chicago’s Booth School of Business, played a significant role in developing DFA’s investment philosophy.
DFA’s investment philosophy is data-driven and relies on empirical evidence rather than speculation. This is influenced by groundbreaking research in finance, including the efficient market hypothesis and studies on factor-based investing such as the three-factor model developed by Eugene Fama and Kenneth French.
DFA takes the emotion out of the equation to deliver reliable results. It has shown over time that it is possible to seek higher expected market returns through the use of science without having to outguess the market.
Over the past several decades this data-driven philosophy has proven successful and has become a preferred mutual fund strategy for investors who share in the belief that success is not arbitrary.
How DFA Mutual Funds are Different
DFA follows a philosophy that uses empirical evidence to arrive at carefully determined “premiums,” or factors, to guide the investment strategy.
Rather than simply looking at past performance and market trends, they take into account these select premium attributes which include relative price, company size, and profitability, all of which aim to have an impact on the fund’s end results and the investor’s bottom line.
DFA’s Factor-Based Approach: Targeting the “Premiums”
1. Company Size: The size factor refers to the historical evidence that smaller companies tend to outperform larger companies over the long term.
In practice, a factor-based strategy might involve overweighting or investing in small-cap stocks compared to their market capitalization weights. This approach aims to capture the potential excess returns associated with the size factor.
2. Relative Price (Value): Stocks with lower valuation metrics, such as low price-to-earnings (P/E) or price-to-book (P/B) ratios, tend to outperform stocks with higher valuations.
Implementing the value factor could involve constructing a portfolio that emphasizes stocks with attractive value metrics relative to their peers.
3. Profitability: Companies with higher profitability, as measured by metrics like return on equity (ROE) or operating margins, tend to deliver better long-term performance.
A factor-based strategy might involve directing the portfolio towards stocks with strong profitability characteristics.
DFA’s investment strategy revolves around carefully selecting securities that demonstrate these factors, aiming to capture systematic sources of risk and long-term market returns within a modern investment framework.
How Dimensional Mutual Funds Differ from Index Mutual Funds
DFA mutual funds and index mutual funds share the same purpose of building wealth with pooled investments, but there are some key differences in their approach:
| Dimensional Funds | Index Funds |
| Accessible through authorized advisors | Direct access for individual investors |
| Managed by individuals who meet DFA’s high standards | No specific requirements for advisors |
| Philosophy based on following the science of investing | Reflects current market trends and past performance |
| Favors small-sized companies with long-term outperformance potential | No specific bias towards company size |
| Considers value in comparison to growth | No specific focus on value or growth |
| Emphasizes profitability as a determinant of long-term performance | No specific emphasis on profitability |
Benefits of Investing in DFA Mutual Funds
1. Lower costs and fees
- DFA does not pay advisors commissions to recommend their funds to investors. This practice tends to deter fee-based advisors who may trade fund assets based on emotions, trends, and performance markets, passing those trade fees along to the client.
- It attracts advisors who embrace a passive investment strategy and value their role of educating and providing guidance for their clients.
- DFA employs disciplined trading practices, such as patient trading and minimizing market impact. This approach aims to reduce transaction costs and prevent negative impacts on portfolio performance.
2. Diversification and risk management
DFA’s mutual fund strategy employs several market strategies to emphasize diversification across different market segments, providing investors with a robust risk management mechanism.
DFA aims to provide investors with exposure to a wide range of market segments, including domestic and international equities, fixed income securities, and alternative asset classes. A few notable strategies include:
- Broad Market Exposure
- Factor-Based Investing
- Structured Portfolios
- Efficient Trading
3. Focus on long-term investing
DFA encourages investors to adopt a long-term perspective and resist short-term market timing or reacting to market fluctuations. This patient approach allows investors to benefit from the long-term performance of the market segments they are invested in.
4. Strong performance track record
The company’s commitment to rigorous research, data-driven methodologies, and a long-term investment perspective has contributed to its strong performance track record.
It’s important to note that past performance is not indicative of future results, and investing involves risks. Factors such as economic conditions, market volatility, and specific company or industry risks can impact investment outcomes.
Therefore, it’s crucial for individuals to conduct a thorough assessment of their financial goals, risk tolerance, and time horizon before making any investment decisions.
Consulting with financial professionals, such as fiduciary advisors or certified financial planners CFP®, can help assess risk profiles, develop appropriate investment strategies, and provide ongoing monitoring and adjustments as needed.
How to Invest in DFA Mutual Funds
Unlike index mutual funds, DFA mutual funds are not readily available to the general public. Investors can only access them through select financial advisors who have undergone a rigorous and lengthy selection process.
This ensures that those advisors managing investor accounts understand and respect DFA’s philosophy of investing based on academic research and the science of investing.
1. Selecting an Approved Financial Advisor
- When you are ready to invest in DFA mutual funds, start by selecting a financial advisor that has been approved to offer DFA mutual funds to their clients.
- They are not likely to make drastic changes to the assets held within a mutual fund on a whim or for their own benefit, thus potentially affecting the portfolios of investors in a negative way.
- Not only are they well-versed in selecting the funds that will provide optimal results based on size, value, and profitability, but these advisors work to educate and provide sound, reliable advice rather than chase trends and try to predict market outcomes.
- Fiduciary advisors working with Dimensional Funds (DFA) are ideal resources due to their obligation to act in clients’ best interests and their expertise in DFA’s unique investment strategies, providing access to well-diversified portfolios and ongoing guidance.
2. Building Your Portfolio
- Once you have selected an approved DFA fund advisor, open a brokerage account to fund your investment.
- By opening a brokerage account, clients gain access to a range of investment options, including stocks, bonds, mutual funds, exchange-traded funds (ETFs), and other securities.
- The brokerage account facilitates transparency and accountability, as clients can view their portfolio holdings, track performance, and receive regular statements and reports detailing their investment activity and account balances.
- The next step is selecting the appropriate mutual funds that meet your investment goals.
- Fiduciary approved mutual fund advisors are the ideal resource to help with this step of building your portfolio.
3. Managing Advisor Fees
- DFA does not pay commissions to approved financial advisors.
- Fees based on service rather than account size result in a rewarding advisor-investor relationship that is fair to both parties. Learn more about fee-only advisors.
DFA & Ferguson-Johnson Wealth Management.
Ferguson-Johnson Wealth Management collaborates with DFA by providing expertise and guidance to clients interested in investing in DFA funds.
As a fee-only fiduciary with more than 40 years of experience, our firm is well-versed in various investment styles, including those aligned with DFA’s philosophy of investing based on academic research and the science of investing.
We work closely with clients to understand their investment goals and leverage our knowledge of DFA funds to build diversified portfolios that align with their objectives.
By incorporating DFA funds into our tailored investment strategies, we aim to maximize profitability and provide our clients with the benefits of DFA’s approach to investing.