How To Use The Core-Satellite Investment Strategy

There are many ways to invest, and typically, what suits your aunt might not suit you. In this post I wanted to introduce you to the core-satellite investment strategy as an option for you to look at to see if it works for you.

The way you invest is very personal to you so generalised strategies that float out there are, in my opinion, there for you to get ideas on what works best for you. You take what suits and leave the rest, and eventually you will have your own unique investment strategy.

Please note that the purpose of this post is NOT to give financial advice, it is for general information only!

What is the core-satellite investment strategy

Essentially the core-satellite strategy is a portfolio construction method with the main focuses on reducing cost and volatility all the while keeping the opportunity to get above average market gains.

What does this mean in practice?

In this strategy the “core” of the portfolio is invested with passively managed funds that track broad indices, like the S&P500 for example.

In example portfolios the core usually makes up 50%, but as with most things with personal finance, there isn’t any particular rule about it.

Just to note though, for the strategy to do what it means to do, the core holding ideally is at least 50%.

The core’s purpose is to reduce cost and volatility.

The satellites on the other hand can be anything else you want to invest in!

The main point is that they are usually more volatile than the core, possibly actively managed or alternative investment options in the hopes of achieving higher than average market returns.

How this works as a strategy

The main point of the core-satellite investment strategy as stated above is to reduce overall volatility and cost, while maintaining the potential to higher than average returns.

This works based on the core being invested in passive investments with low fees, bringing the overall cost of the portfolio down.

These passive investments are usually broad market indices, which means that they track the market overall, examples being S&P500, ASX200 or NZ50, which track the US market, Australian market and New Zealand market respectively.

When an investment fund tracks an index like this, it means that the returns that fund gets are the average market returns.

A passive index tracking fund is cost effective because there is not a lot of buying and selling, or research costs within the fund, compared to actively managed funds.

The satellites on the other hand gives you the opportunity to try to “beat the market”, which just means getting higher than average returns.

For example, if the NZ50 got a return of 6%, beating that market would mean that your portfolio got a return of 8%.

As mentioned above, the satellites can be pretty much anything else beyond the broad index tracking fund.

Individual shares for growth potential, commodities (like gold), actively managed specialty fund (maybe a fund with just companies with women in leadership positions), property (commercial property fund perhaps) or other alternative investments (like cryptocurrency).

The main point is that the weighing (the percentage of your portfolio dedicated to the investment) of the satellites isn’t too much to keep the balance where you want it.

Too big of weighing on a satellite will increase the cost and volatility of the overall portfolio.

Why you might choose core-satellite as your strategy

This investment strategy is a great option for you if you want to have most of your portfolio ticking along in a passively managed index fund knowing it will keep getting the average market return year after year, but you also want to invest in causes you might believe in or investments you believe might offer you a better return.

In the core-satellite strategy you can also add investment options that move differently to shares, further reducing the portfolio volatility.

It gives you a bit more control over the individual investments (or satellites) you put your money in (with the index funds you have no say in what the fund invests in), while still having great diversification (and less volatility) from holding most of your portfolio in the index funds.

With this strategy you just need to remember to re-balance your portfolio if necessary.

If your satellites grow in value quicker than some, the weighing of them in your portfolio will grow and you will be exposed to more volatility because of it.

If you want to read more about portfolio construction, you can find my post about it here and here is a post about the importance of diversification.

If you have any questions, leave them below!