Can You Do Better?

Financial economists at the University of Chicago and elsewhere (notably Eugene Fama and Ken French) have analyzed historical stock market returns and identified factors that outperform the market as a whole over long periods. These are:

1) Small Company Stocks

2) Value Stocks

3) Momentum

4) Low Beta Stocks

All of these effects can be harvested passively. The chart belows shows the performance of these four factors relative to the S&P 500 Index since 1980:

 

Note: These results do not include fees or expenses. You cannot invest directly in an index. While these four sources of outperformance have worked since 1926, they may not work in the future. US Small Company and Large Cap Value Stock data from Fama & French; Momentum Stock data from AQR Capital's Large Cap US Momentum data series; Low Beta stocks are from CRSP database and include stocks from the consumer staples, energy, utilities, and healthcare sectors.

Enter Dimensional Funds

The best way to precisely access the small/value premium is through the equity mutual funds offered by Dimensional Fund Advisors (DFA) -- the firm started by the professors to capture the returns their research uncovered. Dimensional Funds are only available to large institutional investors, or through selected investment advisors like Conservative Wealth Management LLC who are attuned to DFA's patient, long-term investment philosophy.

Dimensional Funds capture the small company and value factors. The DFA Core Funds also utilize momentum to some degree. However, to fully take advantage of the momentum and low beta effects, it is necessary to suppment the Dimensional Fund portfolio.

Modern Portfolio Theory