As independent financial advisers, we are free to construct an investment portfolio using whatever investments that we believe will assist our clients in reaching their goals. However, our starting point in developing such a portfolio is always the institutional mutual funds developed and managed by Dimensional Fund Advisors (DFA). You may ask why that is the case since we are not compensated by DFA?
There are several reasons. DFA was created by some of the leading economic academics based on the belief that risk and reward in the capital markets are related. Thus for most investors, the best approach to helping them reach their goals is to use the historic long-term averages of the various asset classes available to all investors. By doing so, you do not need to worry about timing when the markets will move or worry about picking which stock or bond will outperform others.
This approach allows the individual to develop an investment portfolio that is based on the historic knowledge of the risks of the various publicly traded assets classes. Asset classes are the broad classifications of securities such as large U.S. companies (such I.B.M. or Coca-Cola) or less well-known small Asian-based companies such as Esprit Holdings, LTD – the Hong Kong company that produces high-end fashion or BlueScope Steel – the Australia-based company that produces steel.
The key to developing a portfolio is ensuring that each of the asset classes is pure to allow for controlling the risk taken in achievement of reaching your goals. Therefore, successful investing results from the knowledge of these various markets as well as the understanding of how the markets perform over the short and long term.
For you bakers out there, it is like baking a specific type of cake. The amount of the various ingredients is critical to successfully accomplishing the delicious cake that you want. Same for investment portfolios. As our clients’ portfolio manager, I require that each asset class be controlled to ensure that I get the correct “mix”.
The DFA fund managers stay within the guidelines of each asset class allowing me to build for each client the specific cake that they need and desire. For example, the DFA U.S. real estate fund has only real estate companies located in the United States, regardless if the manager believes overseas real estate will do better this year. Therefore, we can control the risk while achieving long-term goals.
Another reason we use Dimensional Fund Advisors as our starting point is that DFA funds offer strong diversification in each asset class. Rather than select individual companies to represent certain asset classes, DFA’s approach is to start with all companies in the asset classes available for purchase and eliminate those companies deemed not suitable to the portfolio.
Most money managers approach investing exactly the opposite way. They begin with a clean slate and then go about trying to select which companies will be the winners and which companies will be the losers and should be avoided.
We believe, as does DFA, that it is better to use the markets to select the winners because the ability to select the mispriced securities on a consistent basis, while paying extra for their attempts, is futile. It’s like the carnival guessing game that we are all familiar with at a summer fair.
There is a jar of jelly beans and everyone guesses the number in the jar. While most of the guesses are off (and several by large amounts), the collective average guesses is inevitably very close to the correct amount. The markets work the same way. The collective wisdom is better than the best individual guesser most of the time.
These are just a couple of reasons why we are a NJ DFA advisor and use DFA as the starting point for portfolio construction, and for the vast majority of our portfolios, the ending point as well. However, as important as DFA investments are to the overall success of our clients’ investment performance, always remember that your own behavior will be significantly more important than these funds. You can learn more about our partner DFA at www.DFAUS.com.
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