|
While the core/satellite approach to investing sounds like a space-age strategy, it's nothing new. Long popular with institutional investors, it's gaining more attention from individual investors who want to manage risk, return, and investment costs.
A blended approach
The core/satellite approach is essentially an asset allocation model that seeks to resolve the old, ongoing debate between indexing and "active" investing. Advocates of unmanaged, "passive" investing have long argued that the best way to capture overall market return is to use low-cost market-tracking index investments.
But proponents of managed, "active" investing believe that it's possible to beat the market and generate higher returns by hiring skilled managers, picking the right investments, and taking advantage of market trends.
Instead of dictating that you follow one investment approach or the other, the core/satellite approach blends the two together. With the core/satellite approach, you generally keep the bulk or "core" of your investment dollars in cost-efficient investments designed to predictably capture market returns by tracking a specific benchmark. The balance of the portfolio is then invested in a series of "satellite" investments, in many cases actively managed, which typically have the potential to boost returns and lower overall portfolio risk.
Controlling investment costs
Devoting a bit of--rather than the bulk of--your portfolio to actively managed investments can allow you to minimize investment costs that may reduce returns.
For example, consider a $400,000 portfolio 100% invested in actively managed mutual funds with an average expense level of 1.5%, producing annual expenses of $6,000. If, instead, 70% of the portfolio was invested in a low-cost index fund or exchange traded fund (ETF) with an average expense level of .25%, annual expenses on that portion of the portfolio would run $700 per year. If a series of satellite investments with expense ratios of 2% are then used as vehicles for the remaining 30% of the portfolio, annual expenses on the satellites would be $2,400. Annual fees for the core and satellites would total $3,100, producing savings of $2,900 per year. Those savings could be used toward financial planning services, or reinvested back in the portfolio to produce additional growth.
Composing your universe
No rules govern the size or composition of the core or its satellites, and many variations are possible. The size of the core relative to the satellites essentially depends on your investment goals, and how much you're willing to have your overall portfolio results differ from the performance of the core benchmark.
Critical factors in a core/satellite approach are the choice of asset classes and the asset allocation between the core and the satellites, which should reflect your investment goals and risk tolerance. Popular core investments include index funds and ETFs that track specific benchmarks such as Standard & Poor's 500 Index (S&P 500), the Russell 2000® Index, the NASDAQ 100, and various international and bond indices. (See definitions below.) Other popular core investments may track specific style or market- capitalization benchmarks in order to provide a value versus growth bias or a market capitalization tilt.
While core holdings are generally chosen for their low- cost ability to closely track a specific benchmark, satellites are generally selected for their potential to add value, both through enhancing returns and by reducing portfolio risk. Here, too, you have many options. For example, satellite investments might include mutual funds, hedge funds, private equity, real estate, stocks of emerging companies, or sector funds, to name a few. Great candidates for satellite investments include less efficient asset classes where the potential for active management to add value is increased, particularly where those asset classes offer returns that are not closely correlated with the core or with other satellite investments. Since it's not uncommon for satellite investments to be more volatile than the core, it's important to always view them within the context of the overall portfolio.
Although the core/satellite approach isn't right for everybody, it can offer real advantages for some investors. If you’re interested in learning more about core/satellite strategies contact your Stage 2 Advisor. We would be glad to provide you with more information on this topic.
If you would like more information on our firm, please visit us online or e-mail us and a Stage 2 associate will get back to you.
With Warm Regards,
Stage 2 Planning Partners
Josh Patrick © 2006
S&P 500
The S&P 500 index is comprised of 500 stocks that are considered to be widely held. It is probably the most commonly referenced U.S. equity benchmark and comprises over 70% of the total market cap of all stocks traded in the U.S.
Nasdaq 100
The Nasdaq 100 Index is comprised of the 100 largest stocks (based on market capitalization) traded on the Nasdaq National Market.
Russell 2000
The Russell 2000 Index is comprised of the 2000 largest and most liquid stocks based and traded in the U.S. It is one of the most widely used indexes by investors and is generally accepted as the benchmark for small-cap firms.
Sources: www.streetauthority.com, www.investorwords.com
Securities and Investment Advisory Services offered through NFP Securities, Inc., A Broker/Dealer, Member NASD/SIPC and a Federally Registered Investment Advisor.
Stage 2 Planning Partners is an affiliate of National Financial Partners Corp., The parent company of NFP Securities, Inc. Representatives listed on this website are currently registered to conduct securities business in the following states: AZ, CO, CT, FL, IL, IN, MA, MT, NC, NH, NY, PA, RI, VA, VT, WA
NFP Securities is not affiliated with Harris- Murray |
