Blog Article

Splitting Portfolio between DFA and Vanguard

Tyler Bartlett

By Tyler Bartlett, Director of Wealth Management AEP®, AIF®, AWMA®, ChFC®, CFP®
Published On 08/18/2008

I currently have allocated my retirement funds to your Vanguard buy and hold strategy as listed on your website. I have half of the allocation in DFA Funds as I noticed  that some of the Vanguard Funds have performed better over the 5 year period as compared to the DFA ones so that is why I have a combination of the 2 fund families making up the entire suggested investment plan.  I do pay a management fee for the whole portfolio though as all the assets are under the advisors care and maintenance. In your opinion is this a winning strategy to invest in the best performing asset classes from each fund family?


This is a very good question, one which in one way or another is on the minds of many investors these days.

I think the core question you are asking is something like this: Once I have figured out the asset classes I want, shouldn’t I use the funds in those asset classes that have performed best over the past five years?

You are implying two other questions:

  1. Which is better, Vanguard or DFA?
  2. Why has DFA underperformed Vanguard in several asset classes over the past few years?

It’s clear from your question that you have an advisor, and since you are paying that advisor for the Vanguard funds, which you could get without an advisor, the advisor presumably has blessed this arrangement. Without knowing the rationale, I don’t want to try to second-guess that.

If we were your advisor and you asked us about such an arrangement, we would start with the issue of why we make the recommendations that we do. We believe DFA funds over the long term are superior to all others, for a number of reasons you are probably familiar with. To name a few, DFA funds have very low costs, low turnover and massive diversification. Perhaps as important as anything else, DFA value funds concentrate more on value, and DFA small funds concentrate more on small. That gives you more of the benefit of owning small and value.

That benefit, of course, is only available when small-cap stocks and value stocks are doing well. When they are lagging, having more of them puts an extra bit of drag on your portfolio. Like most investors who take the time to think carefully about what you own, you are seeking ways to “optimize” the returns in your portfolio.  The difficulty in that is that the only returns that matter … those in the future … are the ones you cannot know.

It’s always easy to know what you “should” have done last week or last year – or even yesterday, for that matter. But that knowledge does you no good. Past track records are interesting. But a record of only five years is insufficient to make any valid conclusions. What has been “hot” over the last five years has little, if any, relationship to what will be hot over the next five. It’s too bad, because that would make investing a lot easier.

While most performance has some momentum, it doesn’t tend to last very long. You would be nuts to drive down the highway while looking in the rear view mirror. It’s not very smart to do that with investing either – and it has about as much chance of success.

If you are comparing funds in the same asset class, for example the DFA US Large Cap Value and Vanguard Value Index funds) you should do enough digging to understand how they are different from one another. Compare the number of stocks they each own, their expense ratios, average market capitalization, portfolio turnover and price-to-book ratios.

Over the very long haul, we believe that our suggested DFA all-equity portfolio will produce returns that average 1 to 2 percent a year higher than those of a similar portfolio at Vanguard. We know this won’t happen every month, every quarter or every year. It may not even happen every five years.

There is a lot of academic evidence showing that smaller companies (not individually, but collectively as an asset class) are likely to continue outperforming larger companies. Even more reliable, according to what we know from more than 80 years of market experience, is the long-term expected return of value companies over growth companies. Since 1926 the small-cap asset class has had better returns than large-cap in 54 percent of the years and value has been better than growth in 66 percent of the years.

Even with all that evidence, it’s very obvious that nobody can know the future of investments. This is why we advocate a strategy with very wide equity diversification.  Over the last 38 years our studies show that a balance of small, large, value, U.S. and international asset classes did better than the S&P 500 about 63 percent of the time.

If you study the tables in “The best mutual funds: DFA or Vanguard ” you will see that the companies in DFA funds are both smaller and more value oriented than those in comparable Vanguard funds. The tables in that article also compare Morningstar averages of funds within each asset class. It appears that the higher returns of DFA over Vanguard and the Morningstar averages, are neither random nor accidental. I believe they come from the size and value orientation of these portfolios.

As strong as this evidence is, I am afraid that some investors have unrealistic expectations about small-cap and value funds. After seven straight years (2000-2006) of higher returns for the small and value asset classes, some people invested as if this phenomenon would go on forever without interruption.

It didn’t and it never has!

If I had to give you a definitive answer about what you should do with your funds, I would advise you to look far beyond recent performance. Your advisor should be able to help you do that and weigh the relative importance of various factors.

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Tyler Bartlett

By Tyler Bartlett, Director of Wealth Management AEP®, AIF®, AWMA®, ChFC®, CFP®

Tyler has been working as an advisor for over 20 years and now serves as our Director of Wealth Management, ensuring our team of advisors has the guidance and support to provide the best possible service for our clients. As someone who knows firsthand how difficult it can be to find the help you need during challenging times, his goal is for Merriman to be your trusted partner.

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