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Core / Satellite Investing - A simple approach for maintaining a cost-efficient retirement portfolio

Apr. 04, 2011 6:24 AM ET
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Core /Satellite Investing refers to a model for structuring an individual's investment portfolio between:

(1) an efficient, diversified, longer-term portfolio (the core), and 

(2) opportunistic, usually shorter-term investments (satellites).

The core satellite framework balances the individual's need for a risk-controlled, disciplined, investment with the individual's desire to exploit perceived market opportunities and outperform the markets. 

The core portfolio should be composed of broad asset classes - equities, bonds, cash, commodities, TIPS and REITs - ideally in the form of low-cost index funds or ETFs.  The percentage allocated to the different assets is driven by the investor’s risk-return criteria, while emphasizing a diversified approach. As the core portfolio is invested in passive investment vehicles it seeks market-like returns within asset classes. This may not sound like a particularly ambitious or impressive goal, but matching the returns of the market as a whole is difficult due to the pitfalls of "behavioral finance". Human nature works against investors causing them to trade at the wrong time - usually buying at market peaks and selling at market bottoms. By segregating and maintaining a core portfolio of assets that are rebalanced based on pre-determined, objective factors like fixed weights or a consistent dynamic strategy, investors can more easily adhere to a disciplined, long-term retirement plan. A final important consideration in the core portfolio is costs. With the plethora of low cost ETFs and index funds that can be used to cheaply build efficient asset allocations, it’s not worth paying others to seek alpha in the core portfolio.

The satellite investments, unlike the core portfolio, seek "alpha" or market out-performance. A satellite investment can be any investment that satisfies an individual's whim - Apple stock, silver mining ETFs, contemporary art, bank certificate of deposits, whatever. For most investors the core portfolio provides their primary retirement savings while the satellites provide the means to speculate, pursue financial dreams or address immediate cash concerns. Satellites should be subordinate to the core and pursued only after the core portfolio is adequately funded.

In the diagram below, the core portfolio is depicted as the central element with satellite objectives orbiting around it:

Core Satellite Diagram

How much of an individual investor's wealth should be invested in their core portfolio versus satellite investments?
The allocation between core and satellite portfolios can vary based on the investor's age, risk tolerance, their overall wealth relative to their financial needs and their desire to actively manage and trade investments. In the simplified case of an investor with $500,000 in investable assets and a retirement timeframe of 25 years, an advisor might recommend 65-80% of funds be allocated to the core portfolio with at least some of the satellite funds apportioned to cash equivalents.

What should be the composition of the core portfolio?
Financial professionals will offer various preferences for core asset classes. An example of small cap, mid-cap, large cap equities, emerging market funds, global and domestic bonds, REITs, commodities and TIPS can provide a diversified mix that can be used to mitigate the risks of inflation, deflation, equity bear markets, credit defaults and general market volatility that investors will face in broad market cycles.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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