Dimensions

Evidence from practising investors and academics alike points to an undeniable conclusion: Returns come from risk. Gain is rarely accomplished without taking a chance, but not all risks carry a reliable reward. Financial science over the last fifty years has brought us to a powerful understanding of the risks that are worth taking and the risks that are not.

Three Equity Factors

Market Stocks have higher expected returns than fixed income.
Size Small company stocks have higher expected returns than large company stocks.
Price Lower-priced "value" stocks have higher expected returns than higher-priced "growth" stocks.

Everything we have learned about expected returns in the equity markets can be summarized in three dimensions. The first is that stocks are riskier than bonds and have greater expected returns. Relative performance among stocks is largely driven by the two other dimensions: small/large and value/growth. Many economists believe small cap and value stocks outperform because the market rationally discounts their prices to reflect underlying risk. The lower prices give investors greater upside as compensation for bearing this risk.

Size and Value Matter
 
 
Australian stocks in Australian Dollars; US large, US small, non-US developed and emerging markets stocks in US Dollars.

Simulations are free-float weighted both within each country and across all countries. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Compound returns have an assumed rate of return, are hypothetical, and are not representative of any specific type of investment. Standard deviation is one method of measuring risk, and performance is presented as an approximation.

The above data is based on simulated performance data. Simulated performance does not represent actual investments of assets during any period. Note that the performance presented is historical and past performance is not indicative of future performance.
Developed markets value and growth index data provided by Fama/French. S&P data is provided by Standard & Poor's Index Services Group. US Small Cap Index provided by the Center for Research in Security Prices (CRSP), University of Chicago. International Small Cap index data: Jan 1970-June 1981: 50% UK small cap stocks provided by the London Business School and 50% Japan small cap stocks provided by Nomura Securities; July 1981-present: Simulated by Dimensional from StyleResearch securities data; includes securities of MSCI EAFE Index countries, market capitalisation weighted, each country capped at 50%. MSCI data copyright MSCI 2005, all rights reserved. Emerging markets index data simulated by Fama/French from countries in the IFC Investable Universe.

Two Fixed Interest Factors

Maturity Longer-term instruments are riskier than shorter-term instruments.
Default Instruments of lower credit quality are riskier than instruments of higher credit quality.

Dimensional approaches fixed income primarily as a strategy to maximize overall portfolio benefit. Shorter-term, high-quality debt instruments tend to have less risk. Dimensional engineers lower-risk bond strategies so investors can temper their total portfolio volatility or take more risk in equities, where expected returns are greater.

Tour: The Importance of Diversification