In 2003 we came across a mutual fund company called Dimensional Fund Advisors (DFA).  We were interested in their approach, but to be able to participate, we were required to undergo a thorough review process. DFA is quite selective about whom they do business with. They require that an advisory firm has a disciplined, passive, low turnover approach and is fee-based. We became one of only three advisory firms in Washington State accepted to do business with DFA.

This was highly unusual as it is far more typical for mutual fund companies to try to convince us to sell their funds to our clients. In fact, almost everything about DFA proved to be different, in a good way:

Neither Active nor Passive: DFA board member and Nobel Laureate Eugene Fama developed the efficient markets hypothesis (EMH) in his doctoral thesis. An adherence to the EMH causes DFA to avoid a predictive approach which is widely used by active managers. Although not active, DFA management is not passive either.  DFA develops massively diversified baskets of securities without the need to slavishly trade based upon the reconstitution of indexes. This results in low-cost mutual funds with turnover rates generally lower than that of the benchmark indexes. In 1993 The Fama/French Three Factor Model was created by DFA board members Eugene Fama and Kenneth French.  The model expanded on the Capital Asset Pricing Model (CAPM) by adding size and value factors to the market risk factor in CAPM. The Three Factor Model considers the fact that value and small-cap stocks outperform markets over long time periods. In 2012, Fama identified a fourth direct profitability factor, illustrating that in aggregate, companies with higher free cash flow outperform the market.

Opportunistic Trading: Sellers of stock shares are often impatient, causing them to sell large blocks all at once; not all of which can be sold at the current market price. Due to market push, each lot of stock is sold at an ever-decreasing price. As a patient buyer, DFA takes advantage of that. When selling shares, DFA often sells over long periods of time to avoid the results of market push.

Active managers are compelled to buy and sell specific companies as a result of their security research, while passive index fund managers are compelled to buy specific names on specific dates in order to precisely match changes in their benchmark index. By contrast, DFA is flexible regarding which company shares they trade and the timing of those trades. This flexibility results in better pricing and lower trading frictions.

Low Turnover: Active managers typically trade frequently. This high turnover rate is a major component of cost. High turnover is not always the fault of a mutual fund manager, however. Flighty investors who move money in and out of mutual funds can force a fund to buy and sell securities within the portfolio. To combat this, DFA does not offer shares to the retail investor unless they work with an approved advisor or meet very high minimums. Typical minimums are $2 million. In this way, investors in DFA funds enjoy exceptionally low turnover rates.

Vanguard offers open end mutual funds, ETFs, and a variable annuity, and is known for their exceptionally low expense ratios. We find their passive index approach and low costs to be effective, especially when investing in bond mutual funds and bond exchange traded funds.

Deferred variable annuities are generally undesirable investments due to their excessive internal costs.  Vanguard is known for their low-cost approach, and Vanguard’s variable annuity is a good illustration of that. While most variable annuities carry total internal costs in excess of 2%, and often even 3% per year, Vanguard’s offering carries total internal costs of approximately .5% per year.  In those rare cases in which Financial Plan believes it is in the best interests of the client to be invested in a variable annuity, Vanguard is among our top choices.

TIAA CREF is widely known as the premier provider of retirement plans for schools, hospitals, and other non-profit organizations. Less well known is that they are one of only three insurance companies that carry the highest rating from all four independent rating agencies.

TIAA CREF is also a provider of no-load universal life insurance and annuities.  These contracts stand in stark contrast to expensive, permanent life insurance and annuity contracts. We find that the ability to participate in life insurance and annuities without a surrender charge is helpful for many.

Financial Plan periodically reviews the 529 College Savings Plans of the fifty states. For clients who are residents of a state with an income tax, there can be advantages to investing in that state’s plan. For residents in a state without an income tax, such as Washington State, there is little motivation to restrict the selection to the home state. Our criteria in the selection process includes the mutual fund companies that manage the plan, the internal investment costs, and the fee that the state exacts from the plan. Over the past ten years, Financial Plan has changed the plan that we use twice. Currently we are placing our clients into the Utah Educational Savings Plan (UESP) for its access to Dimensional Fund Advisors and Vanguard funds, its low internal costs, and the low .2% fee charged by the State of Utah.

We contract Morningstar as our research engine. Morningstar provides us with robust portfolio management and performance reporting, advanced research capabilities, sophisticated investment planning, and secure client communications using our Morningstar Portal.

We contract By All Accounts to aggregate held-away accounts together with our custodial accounts. This makes it possible for Financial Plan to view holdings and effectively trade on an account regardless of where it is held. For example, in addition to accounts that are held at our custodian, Pershing, we manage held-away accounts such as Fidelity and Vanguard 401k plans, TIAA insurance policies, Utah 529 plans, Vanguard fee-only annuities, TRS plans, and others. The ability to aggregate is important in regard to objectivity and eliminates a conflict of interest.

Financial Plan contracts eMoney to provide a robust investment and tax engine to assist in our financial plans. eMoney provides an intuitive interface, making it easy for advisors to illustrate various aspects of financial plans, including the balance sheet, cash flow statements, straight-line projections for the future, and Monte Carlo projections. Our Plan Dashboard is a personal website that allows clients to view their financial plan online. Important documents can be stored in the website vault. All information is doubly encrypted and protected behind a firewall.