Factor Investing Can Boost Retirement Outcomes

The size, style, and profitability premiums could increase retirement assets by as much as 20 percent.


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Retirement investors can increase their odds of meeting their goals by focusing their stock portfolio on the size, value, and profitability premiums, according to new research from Dimensional Fund Advisors. Advisors should take note.

Dimensional, a $614 billion asset manager that is a longtime proponent of factor investing, compared two portfolios that had a fifty-fifty split of stocks and bonds at retirement. One portfolio used the Center for Research in Security Prices (CRSP) 1-10 index, which tracks the market, while the other used Dimensional’s US Adjusted Market 1 Index, which focuses on the size, value, and profitability premiums. According to Dimensional’s research, both portfolios have broad diversification, low turnover, and only use publicly traded securities.

Dimensional found that the portfolio tilted toward the size, value, and profitability factors during the accumulation phase of investing increased median assets by about 20 percent under both historical and conservative return assumptions at age 65. The accumulation phase is when savers are between the ages of 25 and 65.

Additionally, Dimensional found that emphasizing the premiums reduced failure rates from 4.7 percent to 2.5 percent using a model based on past stock returns. Even under a more conservative model, premium exposure reduced failure rates from 19.9 percent to 12.9 percent. The findings assumed investors would withdraw 4 percent annually over a 30-year retirement. In both cases, the core equity portfolio still had a lower chance of failure.

Retirement planning is one of advisors’ core value propositions, and it is the most used financial planning service used by firms. A survey published last month by J.D. Power indicated that investor satisfaction with their advisors was closely tied to market swings and portfolio returns. The survey showed that year-over-year investor satisfaction had plunged more than 17 points.

“Broadly diversified equity portfolios that pursue the size, value, and profitability premiums can help investors enter retirement with more assets, better sustain their retirement spending, and pass on larger bequests,” Dimensional senior researcher Mathieu Pellerin wrote in the report. “Even moderate exposure to the premiums can significantly improve retirement outcomes.”

According to Dimensional, many of these core equity portfolios are well diversified, have controlled deviations from the market, and can be implemented at low cost. Therefore, they can be implemented into a broad range of retirement solutions including, model asset allocations, target date funds, and managed accounts.

However, this strategy is not without risk.

According to Dimensional, sustained bouts of underperformance are possible and may test the resolve of even the most seasoned investors. If investor satisfaction with their advisor continues to stay tied to market swings and portfolio returns, advisors’ patience with the strategy may also be tested.

But Pellerin continues, “avoiding all tracking error is not a free lunch either, and likely an expensive one, as market portfolios lead to lower retirement assets, higher failure rates, and smaller bequests on average than portfolios with a balanced and controlled emphasis on premiums.”

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