How Targeting Size, Value, and Profitability Can Improve Retirement Outcomes

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Mathieu Pellerin, PhD
Senior Researcher and Vice President
Dimensional Fund Advisors:

Many retirement investors hold equity portfolios that track broad market indices, either
directly or through other investments such as target date funds. Despite their
widespread popularity, market portfolios may leave money on the table. Core equity
portfolios—low-cost, broadly diversified equity portfolios with a moderate emphasis on
the size, value, and profitability premiums—can provide higher expected returns while
controlling the risk of underperformance relative to the market.

In new Dimensional research, we examine the benefits of core equity investing for
retirement outcomes. The potential benefits can start building up in the accumulation
phase. Consider two investors who contribute to a retirement account from age 25 to 65
and follow a conventional target date glide path, in which assets are heavily invested in
equities at younger ages and converge to a 50/50 mix of stocks and bonds by age 65.
The equity portion is invested either in a core portfolio or the broad market without any
emphasis on the premiums. Our results, summarized below, show that an investor in the
core portfolio will typically reach 65 with 15%–20% more assets than an investor in the
plain market portfolio.

DFA Chart showing premium rewards of distribution of assets at beginning of retirement as a function of premium exposure in equity sleeve.
The CRSP Deciles 1–10 Index is a proxy for the market portfolio, the Dimensional US Adjusted Market 1 Index is a proxy for the core portfolio, and five-year Treasury notes are a proxy for bond performance. Results are based on the first of 480 observations (40 years) of 100,000 sequences of 840 bootstrapped monthly, inflation-indexed returns—see the Methodology Appendix for a description of the sample data, data sources, portfolio construction, and spending rules. Assets at the beginning of retirement are based on 480 monthly contributions of $1,042 ($12,500 per year) during the accumulation phase. All numbers are inflation-adjusted using the US consumer price index. Results are based on a portfolio that incorporates equities and fixed income according to a glide path that starts at 100% equities at age 25. The weight in equities is stable until age 45, then linearly declines to 50% by age 65. The historical distribution assumes real expected stock returns of 8.1% vs. 5.0% under the conservative distribution.

The observed benefits of core equity investing continue into retirement. Going back to
our example, let’s assume that both investors retire with a 50/50 split of stocks and bonds
and spend a fixed amount every year. If future stock returns look like past returns, the
probability of failure with either portfolio is low (see Exhibit 1), but the core portfolio still
does better—and, as we show in the paper, also results in a higher average bequest. If
future stock returns are lower than in the past, failure rates increase across the board, but
so does the potential benefit of core equity, which reduces the average failure rate from
20% to 13%. Here, too, the cost of tracking a market index appears steep; the chance of
running out of assets early jumps by 7 percentage points—nearly 54%.

DFA Exhibit showing premium rewards failure rates depending on premium exposure in the equity sleeve
The CRSP Deciles 1–10 Index is a proxy for the market portfolio, the Dimensional US Adjusted Market 1 Index is a proxy for the core portfolio, and five-year Treasury notes are a proxy for bond performance. Results are based on a portfolio with a 50/50 split between equities and fixed income. Failure probabilities are based on a 30-year retirement and a 4% spending rule. Simulation results are based on 100,000 sequences of 360 bootstrapped monthly returns adjusted using the US consumer price index. The average inflation-adjusted expected stock return is 8.1% under the historical return distribution and 5.0% under the conservative return distribution. The sample period runs from June 1927 to December 2022. See Methodology Appendix for details.


Of course, these benefits come at the cost of tracking error relative to the market,
something that market indexing avoids by definition. However, our results show that,
when it comes to avoiding tracking error, the cure may be worse than the disease. The
study finds that market indexing results in initial retirement assets that are 15% lower on
average relative to the core approach. Would you give up an expected 15% of your
retirement assets to avoid all tracking error?

Retirement investing involves long investment horizons, which help improve the
reliability of capturing the premiums and magnify the effect of higher expected returns.
This makes core equity investing an attractive, practical alternative to market indexing—
one that can put retirement investors in a stronger position to reach their goals.

See attached for important sources and disclosures. 




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