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Dimensional Perspectives

Whether you’ve been investing for decades or are just getting started, at some point on your investment journey you’ll likely ask yourself some of the questions below. Trying to answer these questions may be intimidating, but know that you’re not alone. Your financial advisor is here to help. While this is not intended to be an exhaustive list, it will hopefully shed light on a few key principles, using data and reasoning, that may help improve investors’ odds of investment success in the long run.

1. What sort of competition do I face as an investor?

The market is an effective information-processing machine. Millions of market participants buy and sell securities every day, and the real-time information they bring helps set prices. This means competition is stiff, and trying to outguess market prices is difficult for anyone, even professional money managers (see question 2 for more on this). This is good news for investors though. Rather than basing an investment strategy on trying to find securities that are priced “incorrectly,” investors can instead rely on the information in market prices to help build their portfolios (see question 5 for more on this).



In USD. Source: Dimensional, using data from Bloomberg LP. Includes primary and secondary exchange trading volume globally for equities. ETFs and funds are excluded. Daily averages were computed by calculating the trading volume of each stock daily as the closing price multiplied by shares traded that day. All such trading volume is summed up and divided by 252 as an approximate number of annual trading days.

 

2. What are my chances of picking an investment fund that survives and outperforms?

Flip a coin and your odds of getting heads or tails are 50/50. Historically, the odds of selecting an investment fund that was still around 20 years later are about the same. Regarding outperformance, the odds are worse. The market’s pricing power works against mutual fund managers who try to outperform through stock picking or market timing. As evidence, only 23% of US equity mutual funds and 8% of fixed income funds have survived and outperformed their benchmarks over the past 20 years. 



 US-Based Mutual Fund Performance
1999–2018
US Based Mutual Fund Performance

Source: Mutual Fund Landscape 2019, Dimensional Fund Advisors. See Appendix for important details on the study. Past performance is no guarantee of future results.

3. If I choose a fund because of strong past performance, does that mean it will do well in the future?

Some investors select mutual funds based on past returns. However, research shows that most funds in the top quartile (25%) of previous five-year returns did not maintain a top-quartile ranking in the following five years. In other words, past performance offers little insight into a fund’s future returns. 



Percentage of Top-Ranked Funds That Stayed on Top
Percentage of Top-Ranked Funds That Stayed on Top

Source: Mutual Fund Landscape 2019, Dimensional Fund Advisors. See Appendix for important details on the study. Past performance is no guarantee of future results.

4. Do I have to outsmart the market to be a successful investor?

Financial markets have rewarded long-term investors. People expect a positive return on the capital they invest, and historically, the equity and bond markets have provided growth of wealth that has more than offset inflation. Instead of fighting markets, let them work for you. 



Growth of a Dollar
Growth of a Dollar, 1926–2018 (compounded monthly)
Growth of a Dollar from 1926–2018 (compounded monthly)

In USD. US Small Cap is the CRSP 6–10 Index. US Large Cap is the S&P 500 Index. Long-Term Government Bonds is the IA SBBI US LT Govt TR USD. Treasury Bills is the IA SBBI US 30 Day TBill TR USD. US Inflation is measured as changes in the US Consumer Price Index. CRSP data is provided by the Center for Research in Security Prices, University of Chicago. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Long-term government bonds and Treasury bills data provided by Ibbotson Associates via Morningstar Direct. US Consumer Price Index data is provided by the US Department of Labor Bureau of Labor Statistics. Past performance is no guarantee of future results.

5. Is there a better way to build a portfolio?

Academic research has identified these equity and fixed income dimensions, which point to differences in expected returns among securities. Instead of attempting to outguess market prices, investors can instead pursue higher expected returns by structuring their portfolio around these dimensions.



Dimensions of Expected Returns
Dimensions of Expected Returns

Relative price is measured by the price-to-book ratio; value stocks are those with lower price-to-book ratios. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book.

6. Is international investing for me?

Diversification helps reduce risks that have no expected return, but diversifying only within your home market may not be enough. Instead, global diversification can broaden your investment opportunity set. By holding a globally diversified portfolio, investors are well positioned to seek returns wherever they occur. 


Number of holdings and countries for the S&P 500 Index and MSCI ACWI (All Country World Index) Investable Market Index (IMI) as of December 31, 2018. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. MSCI data © MSCI 2019, all rights reserved. International investing involves special risks, such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks.

7. Will making frequent changes to my portfolio help me achieve investment success?

It’s tough, if not impossible, to know which market segments will outperform from period to period.

Accordingly, it’s better to avoid market timing calls and other unnecessary changes that can be costly. Allowing emotions or opinions about short-term market conditions to impact long-term investment decisions can lead to disappointing results.



Annual Returns by Market Index
Annual Returns by Market Index

In USD. US Large Cap is the S&P 500 Index. US Large Cap Value is the Russell 1000 Value Index. US Small Cap is the Russell 2000 Index. US Small Cap Value is the Russell 2000 Value Index. US Real Estate is the Dow Jones US Select REIT Index. International Large Cap Value is the MSCI World ex USA Value Index (gross dividends). International Small Cap Value is the MSCI World ex USA Small Cap Value Index (gross dividends). Emerging Markets is the MSCI Emerging Markets Index (gross dividends). Five-Year US Government Fixed is the Bloomberg Barclays US TIPS Index 1–5 Years. S&P and Dow Jones data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2019, all rights reserved. Bloomberg Barclays data provided by Bloomberg. Chart is for illustrative purposes only. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.


8. Can my emotions affect my investment decisions?

Many people struggle to separate their emotions from investing. Markets go up and down. Reacting to current market conditions may lead to making  poor investment decisions.


Avoid Reactive Investing

Avoid Reactive Investing

9. Should I make changes to my portfolio based on what I’m hearing in the news?

Daily market news and commentary can challenge your investment discipline. Some messages stir anxiety about the future, while others tempt you to chase the latest investment fad. If headlines are unsettling, consider the source and try to maintain a long-term perspective. 

 10. So, what should I be doing?

Work closely with a financial advisor who can offer expertise and guidance to help you focus on actions that add value. Focusing on what you can control can lead to a better investment experience.

  • Create an investment plan to fit your needs and risk tolerance.
  • Structure a portfolio along the dimensions of expected returns.
  • Diversify globally.
  • Manage expenses, turnover, and taxes.
  • Stay disciplined through market dips and swings. 



If you are not already working with a financial advisor, use our tool to locate one near you.

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APPENDIX


Distribution of Luck vs. Skill in US Equity Mutual Fund Performance: 1. The data shown here is derived from the CRSP Survivorship-Bias-Free Mutual Fund Database and Ken French’s data library. Methodology based on Fama and French (2010). Fama, Eugene F., and Kenneth R. French. 2010. “Luck versus Skill in the Cross-Section of Mutual Fund Returns.” The Journal of Finance 65(5) (2010): 1915–1947. Meyer-Brauns, Philipp. 2016. “Mutual Fund Performance through a Five-Factor Lens.” Dimensional Fund Advisors. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. The analysis follows the methodology of Fama and French (2010) and French (2008) using the Center for Research in Security Prices (CRSP) mutual fund data from 1984 to 2015. Only funds that invest primarily in US equities were included and different classes of the same fund were combined, with asset weights, into a single fund. To better focus on the performance of active managers, index funds were excluded from the analysis. To lessen the effect of incubation bias, funds with less than $50MM in assets under management as measured in December 2015 US dollars were not included in the analysis. A return history of at least 12 months after exceeding the $50MM AUM minimum for the first time was required to facilitate estimating benchmark regressions. Only funds that appear on CRSP at least five years before the end of the sample period were included in order to avoid a large number of new funds with short return histories. Tests for non-zero true α in actual fund returns use bootstrap simulations on returns that have the properties of fund returns, except that true α was set to zero for every fund. To set α to zero, a fund’s five-factor α estimate was subtracted from its monthly returns. A simulation run is a random sample (with replacement) of 384 months, drawn from the 384 calendar months of January 1984 to December 2015. Benchmark regressions were then estimated, fund by fund, on the simulation draw of months of zero-alpha adjusted returns, and funds that are in the simulation run for less than 12 months were excluded. 10,000 simulation runs were performed to produce a chance distribution of t(α) estimates for a world in which true α is zero. The projections or other information generated by bootstrapped samples regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results will vary with each use and over time.


Industry Mutual Fund Performance: 2. The sample includes funds at the beginning of the 15-year period ending December 31, 2017. Each fund is evaluated relative to the Morningstar index assigned to the fund’s category at the start of the evaluation period. So, if, for example, a fund changes from Large Value to Large Growth during the evaluation period, then its return will still be compared to the Large Value category index. Surviving funds are those with return observations for every month of the sample period. Winner funds are those that survived and whose cumulative net return over the period exceeded that of their respective Morningstar category index. US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Index funds and fund-of-funds are excluded from the sample. See Dimensional's “Mutual Fund Landscape 2018”for more detail, including Morningstar categories included in the fund samples. Past performance is no guarantee of future results.

Past performance is no guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Diversification does not eliminate the risk of market loss. There is no guarantee investment strategies will be successful. Investing involves risks including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.