Business owners and creatives are always asking me how to invest their (passive) incomes. My favorite method (but by no means the only strategy) is to use what is called a Core & Satellite strategy. I will describe it below.
[Disclaimer: Building your investment portfolio will depend on a number of factors, such as your risk profile, your time-horizon and your individual goals. This article should in no way be considered advice. You should meet with an adviser than can take into account your situation, when planning your portfolio.]
In order to maintain a well-balanced and diversified portfolio, a common strategy is to split your assets into ‘core’ and ‘satellite’ investments. The goal with Core and Satellite strategy is to increase diversification, while providing the potential for higher returns than a index fund alone might provide.
This strategy typically involves investing the ‘core’ of your portfolio in lower cost and (hopefully) lower risk funds, while your smaller ‘satellite’ investments tend to be more tactical. These tactical 'satellite' funds can also be passive, but they may be actively managed as well.
Why core and satellite funds?
The idea behind the core/satellite strategy is to give your portfolio some sort of structure. A portfolio lacking structure can lead to a mishmash of investments, which can result in unknown risk levels. Risk is something that all investors should understand.
Core and satellite is also relatively simple to rebalance every year, and it is visually easy for some people to understand -- a core with smaller funds surrounding it.
What should form the core of your portfolio?
Your core holdings should provide stability to your portfolio and should match your risk tolerance and investment horizon.
One option is to invest the ‘core’ of your portfolio in low cost index funds and your smaller satellite investments in actively-managed funds. Another option is to invest in an active “balanced” fund that has low fees. The goal is for a broad based fund with low fees and above average performance.
The core will make up 60-90% of the portfolio, and since it is low cost, you keep overall fee levels down on the portfolio. I prefer funds that aren’t overweight the mega-cap stocks. Rather, I like funds that are spread fairly equally between large, mid, and small stocks.
We also prefer that the core have exposure to developed foreign markets, like Europe, UK and Japan. We can get our emerging market exposure in one of the “satellites.”
What should form the satellite of your portfolio?
Satellites are commonly sector-specific or thematic funds in tech, biotech, energy, emerging markets, commodities, high yield debt, REITS or energy to name a few.
The satellites are a good place to rely on industry expert fund managers. A fund manager may have decades of experience evaluating a sector or country. This can be place to seek alpha -- or outperformance.
I hope that is a decent enough description of how the Core and Satellites strategy can work for someone. There are no hard and fast rules, but it does provide an overall framework to work from. If you have questions, let me know.
I am a Chicago-area financial adviser to young doctors & business owners.