At the end of the day, the gap between low-cost open-end index funds and ETFs is a crack in the sidewalk. The gap between either of these and the average actively managed fund is the Grand Canyon.
Reams of Internet ink has been spilled in articles and discussion boards debating the merits of Vanguard index funds vs. Dimensional Fund Advisors' lineup of passive asset class funds.
However, the dispute really comes down to one major difference in investment philosophy, according to Bill Bernstein, editor of http://www.efficientfrontier.com/, as well as the already classic book "The Intelligent Asset Allocator."
"The basic difference between DFA and Vanguard is that the folks in Santa Monica believe in premia for value and small stocks, while those in Valley Forge do not," said Bernstein in an email interview.
That fundamental divergence is reflected in many aspects of each firm. Vanguard's retired founder John Bogle and its chief investment officer Gus Sauter have for years advocated market-cap weighted total market index funds. Indeed, both are personally invested heavily in total market index funds, according to filings from Vanguard. However, Vanguard does offer small-cap and value index funds, although they are not as concentrated in these areas as DFA's funds.
DFA funds, which are sold only through financial advisors, tend to be tilted more toward value and small-cap stocks, which have historically outperformed, although with more volatility.
"I think that DFA is right, but even if you believe in their approach, there is no certainty that they are right, or even if they are, that your time horizon will be sufficiently long enough to collect those premia -- that's why they're known as risk premia," said Bernstein.
DFA is known for its expertise in trading the tiniest stocks, and for its tolerance for index tracking error.
"If you can embrace the modest tracking error associated with ultra-low turnover and finicky transactional behavior, you should outperform even your best indexed peers by a small margin, and with small cap and value stocks, you'll also dramatically increase your tax efficiency," said Bernstein.
Although Bernstein clearly favors DFA funds, he thinks the Vanguard index funds have been improved with new MSCI U.S. equity benchmarks.
"They're an improvement, in general, over the S&P indexes, because of the lower transaction expenses of indexing them," said Bernstein. "Not as good as a completely passive approach, which avoids transacting merely to match the index precisely as much as possible, but better."