Comparing Dimensional's US Strategy to the Overall US Market
The US share market is great for case studies as the available data goes all the way back to 1927. For the examples below, we will compare the S&P 500, the most popular index for the overall US share market, to a typical Dimensional US share strategy.
The Dimensional Strategy is made up of:
1/3 Dimensional US Large Cap Index
1/3 Dimensional US Large Cap Value Index
1/6 Dimensional US Small Cap Index
1/6 Dimensional US Small Cap Value Index
Through these weightings to small and value companies, Dimensional aims to outperform the market while remaining widely diversified.
The chart below shows the calendar year returns for both the Dimensional strategy and the S&P 500 from 1927 - 2019.
Over time, we see a lot of ups and downs. Also, it is difficult to see which of the two options has done better. To make it easier to judge the performance, we can subtract the S&P 500's return from Dimensional's return. When the difference is positive, Dimensional has outperformed. Sorting the years from best to worst gives the chart below.
At a glance, it seems Dimensional's strategy outperformed the S&P 500 about half the time (actually 55% of the years shown).
It is important to note, outperformance in good years significantly outweighs underperformance in bad years. About 20% of years have an outperformance of more than 10%(!) while four have an underperformance of more than 10%.
If you are invested for the long-term, these good years stack up nicely. Below is the same chart, but showing decades instead of years. The decades overlap (e.g. 1990 - 2000 is included alongside 1991 - 2001).
This shows how the odds are stacked in Dimensional's favour over longer time frames.
There are some bad decades, but only about 20% of the total. We also see the same trend as before, where bad decades result in slight underperformance when compared to outperformance in good decades. Also, underperformance doesn't necessarily mean a loss in these examples, only a return lower than the market as a whole.
We have just experienced a decade where Dimensional's strategy has underperformed the index. It may be tempting to jump ship following this disappointing run.
First off, a common caveat in the investment industry is "past performance does not guarantee future returns". There is no reason to believe performance will suffer going forward because of what happened in the last 10 years. There may be reason to believe the opposite.
Let's look at the 17 periods, from the full set of 92 decades, where Dimensional underperformed. Then we can see how Dimensional's strategy performed in the following decade.
Historically, underperformance has not continued following a bad decade. In fact, previous bad decades have been followed by a period of outperformance.
For investors who stayed in their seats, the outperformance in the following decade was large enough to offset the previous ten years in all of these periods.
We will have to wait and see whether these trends continue, but history tells us to expect good times to come.