Fifty years ago, most twenty-four-year-olds living in San Francisco were more interested in reading Rolling Stone and following the Grateful Dead than in reading the Wall Street Journal and following the stock market. But that was when Mac McQuown, a man with an engineering background, recruited twenty-four-year-old David Booth, who had recently graduated with an MBA from the University of Chicago Graduate School of Business, to come to work for a financial think-tank he was forming at Wells Fargo. “We were excited by the opportunity to turn academic research into a new way of investing,” Booth says. “Many people thought we would fail. Some even called what we were trying to do, ‘un-American.’”
What was this revolutionary idea? “We focused on how indexing could improve the lives of investors,” Booth explains. “The [mutual] fund offerings available at the time were actively managed portfolios that tried to outguess the market and were expensive, lacked diversification, and performed poorly … there was no compelling evidence they could reliably beat the market. We were confident that indexing—a highly diversified, low-cost investment solution that relied not on a manager’s ability to pick winners but on the human ingenuity of hundreds or thousands of companies—would change lives for the better.”
With a team that included twelve of the brightest minds in academic financial research—including six who would go on to win the Nobel Prize in Economics—McQuown, Booth, and their group developed the idea of index investing: matching one’s investments to the makeup of a broad index such as the S&P 500 and other aggregates made up of a large cross-section of the market. Today, after some $9.1 trillion has been invested in index funds and exchange-traded funds (ETFs), this hardly sounds “un-American,” or even unusual. But at the time, what Booth, McQuown, Eugene Fama, and others were doing was groundbreaking, preceding even the innovations spurred by Jack Bogle, who launched the first indexing fund available to retail investors—the Vanguard 500 Fund—in 1976.
Booth and a graduate school friend, Rex Sinquefield, would go on to apply a similar concept to other asset categories, including small-capitalization companies, value stocks, international investing, and others. They launched Dimensional Fund Advisors in 1981, powered by the concept that investors could capture better expected returns, over time, by allocating assets across several “dimensions” that categorize opportunities. For equities, the dimensions are company size, relative price (value vs. growth), and expected profitability. In fixed income, the dimensions are duration (time), and quality (credit rating). By diversifying portfolios across as many dimensions as possible, investors can expect to achieve long-term success in overall returns and less volatility than if assets were concentrated in fewer areas.
The driving force behind the Dimensional approach is that, rather than trying to outguess or time the market, it utilizes the very thing the financial markets do best—fairly valuing assets based on as many factors as possible—in order to capture value for investors. As years of research demonstrate, no investment advisor or fund manager has a working crystal ball. Rather than try to predict price movements, the Dimensional concept harnesses the broad power of the markets themselves to help investors reach their financial goals.
As a fiduciary wealth manager and financial advisor, my sole focus is to put my clients’ needs and interests first, in everything I do. This means, among other things, that I want to help each client become as well-informed as possible about the financial markets and how they work to deliver value. To learn more, click here to download my white paper, “The Informed Investor.”
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