Investing in the stock market can seem daunting. There are countless strategies and asset types to choose from, each with its own set of risks and potential rewards. One strategy that has gained popularity in recent years is Dimensional lnvesting. There are multiple reasons why this approach can turn the heads of investors.
However, the fact that Barron’s rated them the #1 mutual fund family for 2022 (and #5 in 2021) could have something to do with it. In this article, we dive into DFA Investing: what it is, how to choose the right investments, how it compares to other investment strategies, and how to make successful DFA Investments.
This article discusses these topics:
- What are DFA Investments?
- Choosing the right DFA Investments
- DFA Investing vs. other strategies
- Making successful DFA Investments
What Are DFA Investments?
DFA’s approach to Investing focuses on diversification and discipline and minimizes expenses and taxes—while isolating factors associated with higher ROI. This strategy is based on the idea that certain factors (such as company size, price-to-book ratio, and overall profitability) have historically been associated with better-expected returns.
By investing in a diversified portfolio of stocks that have high exposure to these factors, DFA Investing seeks to capitalize on them. Dimensional Fund Advisors (DFA) originally designed their investment products to capture these dimensions of the market.
These funds are available to individual investors through affiliated financial advisors. They are also used by institutional investors, such as pension funds and endowments, as well. One of the key advantages of DFA’s approach is that it allows investors to take advantage of market inefficiencies that can arise due to behavioral biases and other factors.
By focusing on the underlying factors driving returns (rather than attempting to “beat” or time the market), investors can potentially achieve solid returns while reducing risk. Another advantage is that DFA Investing is grounded in rigorous academic research conducted by some of the most respected academics in finance. It has been subjected to extensive peer reviews and replication, as well.
Choosing the Right DFA Investments
In order to determine the optimal DFA Investments for your unique financial circumstances, you need an understanding of the various market factors. It also helps to know how these metrics’ data can be captured through different investment products.
Here are some of the most common factors that a possible investor should consider:
- Dimension Exposure. Different DFA funds have different exposure to the various market premiums. For example, the DFA US Large Cap Value Fund (DFLVX) is designed to capture the value premium of the US large-cap market, while the DFA US Small Cap Fund (DFSTX) is designed to capture the small-cap premium. It is important to choose funds aligning with your financial goals and risk tolerance.
- Fees. Like any investment product, DFA funds come with fees. These costs can vary, depending on the fund. This makes comparing the costs of other funds to ensure that you are getting a good value.
- Investment Horizon. DFA Investing is a long-term strategy, so it is important to have an investment horizon in mind when utilizing it. Short-term fluctuations in the market can be unpredictable, but over the long haul, DFA’s focus on changing market premiums has historically been associated with higher returns.
DFA Investing vs. Other Strategies
Again, Barron’s rated DFA Investing Funds as the #1 mutual fund family for 2022. The involvement of Eugene Fama (a Nobel laureate) and other leading academics as directors and consultants to Dimensional Fund Advisors is also noteworthy. However, to better appreciate DFA funds’ advantages, we should consider how the strategy compares with other approaches to investing.
DFA Investing seeks to capture the long-term returns of the market through a diversified portfolio of low-cost, managed funds. This approach is based on the belief that attempting to time the market is a challenging task and that investors are better off sticking to a long-term investment plan.
Compared to other approaches, DFA Investing takes a more long-term approach, meaning that its funds are designed to track a particular index or set of dimensions. This is in contrast to a more tactical style of management in which a fund manager tries to beat the market with investment decisions based on their own analysis and research.
Diversification is another key component of DFA Investing. By investing in a deliberately-varied portfolio of stocks with high exposure to certain dimensions, you may reduce your overall portfolio risk. Conversely, investing in individual stocks or concentrated managed funds can be more. Risky.
Factor investing is another key differentiator between DFA-style investing and other approaches. This subset of DFA Investing focuses on stocks exhibiting certain factors, such as value, momentum, or quality, that may be associated with higher potential returns.
Making Successful DFA Investments
Investing, in general, is an art and a science that requires patience, discipline, and a thorough understanding of the market. DFA Investing, while often rewarding, can require greater patience. That is why the following steps can provide a good starting point.
1: Identify Your Investment Goals & Risk Tolerance
Just as your investment goals will determine the type of investments you make, your risk tolerance will determine the level of risk you are willing to take. For instance, if your goal is to save for a comfortable retirement in 20 years, you may be willing to take more risk than if your objective were to buy a new car within 5 years.
2: Build a Diversified Portfolio
DFA Investing focuses on capturing the returns of broad-based asset classes, including small-cap stocks, value stocks, and international stocks. We can help you build diversified equity across a variety of investments.
3: Focus on Risk Premiums
Risk premiums are the returns that investors can expect for taking on specific types of risk. For instance, small-cap stocks and value stocks have historically offered higher returns than large-cap stocks and growth stocks, respectively. By focusing on these, a Dimensional investor may capture higher returns over the long term.
4: Choose an Investment Advisor
Investing is always easier with financial advice from a CERTIFIED FINANCIAL PLANNER™ who adheres to the fiduciary standard. Ideally, your wealth manager should have a deep enough understanding of the principles of DFA Investing to guide you through the investment process.
TFA, a North Carolina financial advisory firm, has the extensive experience necessary to help you leverage this systematic long-term strategy. We’re your Carolina retirement planners in Greensboro, NC. To learn more about evidenced-based investing, estate planning, and developing a retirement plan, contact us.