Dimensional versus Vanguard: A Test of Simple Factor Investing

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This article originally appeared on ETF.COM here.

There is overwhelming evidence that simple indexing strategies outperform the vast majority of investors, be they individuals or institutions.

Perhaps the simplest strategy, as advocated in the new book by Taylor Larimore, is to hold just three funds.

For equities, you can own the Vanguard Total Market Index Fund (VTSMX) and the Vanguard Total International Stock Index Fund (VGTSX). On the bond side, you can own the Vanguard Total Bond Market Index Fund (VBMFX). Had you owned such a portfolio over the past 20 years, you would have outperformed most investors. This approach is not only a very good one, but will continue to outperform a large majority of investors going forward.

That said, such an approach ignores the academic evidence demonstrating there are certain factors that have provided above-market returns to investors willing and able to accept their additional risks.

These factors have performed with persistence across long periods; pervasiveness across sectors, countries, regions and even asset classes; and robustness to various definitions. What’s more, they have intuitive risk-based or behavioral-based explanations for why they should persist and are implementable, meaning they survive transaction costs. The two factors with the longest history are size and value.