If I Could Invest In Only One Fund . . .
Which fund is my #1 pick out of 7,000 mutual funds? Attributes of my top fund: low fee, low turnover, low risk of strategy obsolescence. Value beats Growth; Small Cap beats Large Cap. If I could invest in only a single fund . . . . . . and I had to invest all of my equity investment dollars in this fund . . . and I could only own this single fund for the rest of my life . . . which fund would I pick? Given that there are roughly 7,000 mutual funds available in the U.S. today, the above scenario of having to invest in only a single fund is admittedly not realistic. However, if you can come up with a good answer for it then you have probably found yourself a fund that deserves a significant share of your investment dollars. For me, I am looking for a fund that has a combination of the following attributes: 1. A time-tested, consistent and successful investment strategy based on empirical evidence of what actually works in investing. The strategy must also have low risk of obsolescence over time. (Thus, it must be a numbers-driven strategy). 2. Broad diversification – I can’t have the risk of too much money in a single stock 3. Low fees – I want a very cheap fund that is an excellent business proposition. 4. Tax efficiency – I need a fund that has very low turnover (trading)-and consequently high tax efficiency and very low drag on returns. Here is my personal investment profile: I am a long-term oriented and risk tolerant investor looking to maximize wealth over decades, not in any one year. Given my investment objective and my fairly high tolerance for risk, the fund I would choose for myself out of the 7,000 possibilities if I were able to invest in only one fund for the rest of my life is the Dimensional Small Cap Value Portfolio (MUTF: DFSVX ). Why does this particular fund top my list? There are many reasons, but here are my biggest 5: 1. Value Beats Growth The first reason is the fund’s value focus. Investors everywhere should understand a basic historical fact of stock markets: Value stocks-stocks that are cheap by financial measures-have outperformed growth stocks, their more expensive, glamorous and news-worthy cousins, by a wide margin. This is true both in the U.S. and in overseas stock markets. Does value outperform growth every year? No. Is there any guarantee that value will outperform growth in the future? No. But that’s a risk I’ll happily take. The data are compelling. And this Dimensional fund takes value seriously: the average price-to-book value ratio of its individual holdings is a mere 1.16x. It’s chock full of cheap stocks. 2. Small-Cap Beats Large-Cap The second reason is the fund’s small-cap focus. Here’s another thing all investors should know: it is a matter of record that historically small company stocks have delivered better investment performance than large company stocks, albeit with more volatility. For me, the extra volatility is ok. Remember, I’m a long-term investor looking to maximize my wealth over the coming decades-not in any one year. Any big swoons will just be opportunities for me to increase my small-cap value holdings. And as with the value versus growth comparison, the phenomenon of small-caps outperforming large-caps is true in both U.S. and overseas stock markets. Do small-caps outperform large-caps every year? No. (In fact, U.S. small-caps lagged large-caps in 2014-after beating them handily in 2013. Does the fact that large-caps beat small caps in 2014 do anything to diminish my confidence in the long-term outlook for small caps? No.) 3. Broad Diversification The Dimensional Small Cap Value Portfolio is also very well diversified-much more so than the vast majority of small-cap funds. The fund currently holds more than 1,200 stocks, thereby greatly reducing the possibility that the performance of any single stock will dramatically affect overall fund performance. It is important to understand that the fund’s objective is to efficiently capture the returns of the world’s top performing equity segment-small-cap value stocks-not hit a home run on any single stock. The fund’s numerous underlying holdings enable it to do just that. 4. Consistency of Strategy and Low Risk of Obsolescence If I’m going to be locked into an investment for the next 50 years (I hope), I want it to have a consistent, reliable, data-driven strategy that does not depend on the investment acumen of any human (or group of humans). My chosen fund is managed according to quantitative factors. Stocks enter or exit the portfolio based on their quantitative value or size characteristics, not because of a judgment someone had to make. It is of course true that humans created Dimensional’s investing algorithms, but now the strategy has 30-plus years of successful performance history under its belt and requires minimal tinkering (in my opinion). 5. Very Low Costs It is critical for investors to mind the costs of their funds. The range of expenses among funds is very wide and fees are often disclosed only deep in mind-numbing fund prospectuses. The net expense ratio of my chosen fund is a mere 0.52%, however, which is a significant discount to the average fund. In addition, my chosen fund has annual turnover of only 14%. Its light touch on trading keeps a lid on costs and makes the fund more tax-efficient as well. Portfolio turnover (buying and selling) creates costs for a fund but such trading costs are not disclosed explicitly and cannot be predicted accurately. Many mutual fund managers turn their funds over in excess of 100% per year (i.e. only hold the average stock for one year), and in the process rack up huge costs that are passed through to the underlying investors. In some cases investors may be squandering 2%-3% per year of performance right out of the gate simply by owning a high-turnover fund. To sum it up, Dimensional Small Cap Value Portfolio has the right combination of attributes that make it my top pick out of 7,000 funds if I were required to put all of my money into a single fund for the rest of my life. Investors considering taking a similar approach to me but with ETFs instead of mutual funds may want to check out the iShares Russell 2000 Value ETF (NYSEARCA: IWN ) or the iShares S&P Small Cap 600 Value ETF (NYSEARCA: IJS ). For an option that has a more large-cap focus but useful rebalancing methodology, the Guggenheim S&P 500 Equal Weight ETF (NYSEARCA: RSP ) might be worth some consideration. Investors should take note that the average market cap of the holdings in each of these funds is substantially higher than that of the holdings of the DFA Small Cap Value Portfolio, however. To learn more about Dimensional Funds and how we employ them in client portfolios, please visit us at www.orionportfolios.com .