We believe markets are efficient.
For as long as there have been financial markets to invest in, people have been trying to figure out ways to beat the market. Before the advent of mutual funds, stockbrokers were selling individual stocks and bonds to their clients. With the evolution of mutual funds, investors have gained the benefit of economies of scale by pooling their money with other investors. Professional managers were hired to develop a portfolio of stocks (or bonds or other investments) to invest these monies. These managers were attempting to outperform the market to keep their investors invested in their funds. The trouble is that history has shown us that 85 percent of these managers under-perform the “market.” The index fund evolved from such research, and just by replicating the market returns, it was able to beat the majority of actively managed mutual funds. At Lifetime Wealth, we go a step further and use institutional asset class (index-like) funds to construct client portfolios. These asset class funds were developed through further academic research designed to maximize the returns for different segments of the market.
We believe that diversification reduces risk and increases return.
Most investors realize that, for a portfolio of individual stocks, diversification reduces their risk of loss. This strategy supports the old adage “don’t put all your eggs in one basket.” In fact, you can essentially eliminate individual security risk (that any one company will go belly-up) by holding a large number (hundreds) of securities in a portfolio. Most investors diversify to eliminate this individual security risk through the use of mutual funds. However, you can further reduce your portfolio volatility (market risk) by holding a diversified portfolio of mutual funds (e.g., international, small value, large growth). Furthermore, research conducted by Fama and French has shown that diversification can actually add about one-half a percent per year to the compound returns of a 60–40 portfolio (60% stock, 40% fixed income) by dampening portfolio volatility (i.e., market risk). We create highly diverse portfolios that exploit these benefits of diversification.
We believe that utilizing institutional asset class funds increases expected return and predictability for our client portfolios.
The preeminent firm in applying academic research to engineer structured asset class investments is Dimensional Fund Advisors (DFA). We utilize DFA’s institutional funds to construct our client portfolios. There are several reasons that we use DFA funds.
- DFA funds are very low cost; similar in cost to Vanguard mutual funds.
- DFA funds are designed to maintain consistent exposure to the target asset class, and are thus not susceptible to style drift or chasing after the hot stocks or asset class (for example, the internet stocks of the late 1990s).
- DFA has developed trading strategies that have resulted in negative trading costs. DFA has become one of the largest de facto market makers for small and micro cap stocks. As a result, DFA is often able to keep the difference between the bid and asking price (the “spread”) when approached by other institutional investors looking to buy or sell large blocks of stock.)
- DFA funds are not available to retail investors. Therefore, our clients are not susceptible to panic selling by the general investing public and the resulting mutual fund redemptions that generally occur. This activity usually results in higher capital gain (distribution) exposure and increased trading costs.
- DFA is at the forefront of cutting edge research into financial markets, the dimensions of stock returns, and the term structure of interest rates. Some of the most distinguished academics in financial economics, including Nobel Prize recipients, are on the DFA’s Board of Directors and direct DFA investment strategies.
For these reasons and more, DFA is the provider of choice to construct our portfolios. There are, however, certain circumstances when we will use some retail index funds or exchange traded funds, individual bonds or individual securities for a portion of a client’s portfolio due to client-specific needs. We evaluate each client on an individual basis and determine what strategies to apply to his or her unique circumstances.