Vanguard Funds vs. DFA Funds Study Shows: All Costs Are Not Equal

DFA vs. Vanguard Study Shows:

 Investors Should Be Focused On Value Not /Costs

                                                                                                 By: Brendan Magee

                                                                                                       July, 2011

Duke University professor Edward Tower and University of Wisconsin Professor Cheng-Ying Yang conducted a study between the widely known Vanguard Fund Group and the not so widely known Dimensional Fund Advisors (D.F.A). The basis of the study was to see if the low-cost marketed do-it-yourself giant  fund group would be more beneficial to investors than D.F.A.’s go through an advisor paying higher fees for the services of an advisor approach. The study was conducted from the time period 1997 through 2006.

It’s not often that investors are encouraged to engage in a conversation that focuses on value for the costs incurred,  because the majority of the time investors are told to focus on lowering expenses, not on whether or not those fees are producing value. So this is a great opportunity.

Let’s first familiarize you with who DFA is. They are an institutional investment firm. They are not advertised on the golf tournaments or the N.F.L., but they have deep roots amongst the academic community. Their board of directors includes Nobel Prize winners and highly decorated professors from the University of Chicago, Yale, Stanford, etc. They provide pension service for some of the country’s biggest companies like I.B.M., Pepsi, municipality’s pension funds, and college endowments. For the everyday investor, the only way to get access to their funds is through an advisor who has been approved by D.F.A.

For the eight year period used, Tower and Yang found that the D.F.A. funds outperformed Vanguard funds by an annualized 2.57% and concluded that it was worth paying the additional advisory and custodial fees charged by D.F.A. So what does this mean to the investor? Assume a $100,000 account that underperforms by 2.57% per year. That is $2,570 per year. Let’s assume we’ve got a 25 year period of time we are investing in and the portfolio has an expected 8% per year annualized  expected rate of return. That would mean that our portfolio has missed out on $187,882 in returns. Ouch!!

   It is important to understand  that this study is solely comparing returns  of the two fund groups. This does not take into consideration any value added services. Advisors services can include avoiding imprudent behavior like market timing, chasing after perceived hot sector investments, adherence to disciplined investment strategies, etc.

The study went on to pretty eye opening conclusions. For one thing, Vanguard did not offer certain asset classes that would be included in DFA portfolios. For example Vanguard did not have a Micro Cap Fund. When Vanguard portfolios could be constructed and matched to a similar DFA portfolio Vanguard’s portfolio underperformed the DFA portfolio by 3.02% per year for the eight year period tested with a lower amount of risk.

Another eye opener was when the study compared DFA and Vanguard’s funds on a domestic and international basis. The study showed that from 1997-2006 DFA’s domestic funds outperformed Vanguard’s by an annualized 2.61% and internationally DFA came out on top by 3.59% continuosly.

For my own research I looked at the funds on an individual basis using Morningstar’s data base. Here’s how some of the funds compared to one another over the last 10 years:

Vanguard S&P 500 Index                            DFA U.S. Large Co. Fd.

Cost 18 basis pts                                          Cost 10 basis pts.

10 yr. ann. Ret. 1.35%                                   10 yr. ann. ret. 1.40%

Vanguard U.S. Lg. Val.                                 DFA U.S. Lg. Val.

Cost: 14 basis pts.                                        Cost: 16 basis pts.

10 yr. ann. ret. 2.09%                                    10 yr. ann. ret. 5.44%

Vanguard U.S. Sm. Cap                                DFA U.S. Sm. Cp

Cost: 28 basis pts.                                         Cost: 40 basis pts.

10 yr. ann ret. 7.34%                                      10 yr. ann. ret. 9.63%

In these examples you can see that Vanguard in some cases is the cheaper fund and sometimes they are not, but in every case the DFA fund has outperformed the Vanguard fund by enough to more than offset the cost. You could even say the less expensive fund is really costing you more because of the returns the investor is missing out on. This is not to say that past performance is any indication of future returns, but if you belief that over time markets will produce returns as they have in the past, the better value is DFA and having an advisor. Again all costs are not created equal.

(If you’d like to see the full version of this study e-mail Brendan@coachgee.com)

Brendan Magee is the president and founder of Inevitable Wealth Coaching located in Drexel Hill, Pa. With questions, comment, or suggestions, call 610-446-4322 or e-mail Brendan@coachgee.com.