Core and Satellite is a common and time-tested investment portfolio design that consists of a "core," such as a large-cap stock index mutual fund, which represents the largest portion of the portfolio, and other types of funds—the "satellite" funds—each consisting of smaller portions of the portfolio to create the whole. The primary objective of this portfolio design is to reduce risk through diversification (putting your eggs in different baskets) while outperforming (obtaining higher returns than) a standard benchmark for performance, such as the S&P 500 Index. In summary, a Core and Satellite portfolio will hopefully achieve above-average returns with below-average risk for the investor.
Begin With the Core:
The best core holding is a diverse large-cap stock fund, such as a low-cost S&P 500 index fund. The core will represent the largest portion of your portfolio. A good percentage for a moderate portfolio, for example, is 30-40%.
The reason large-cap index funds work well as core holdings is because information about large companies, such as Wal-mart, GE, Exxon and Microsoft, is so readily available to the public that it is extremely difficult for investors to consistently out-perform the market, especially over long periods of time. In other words, if even the pros have a difficult time beating the S&P 500, why should you do any better? You can learn more about this concept and the reasoning for using index funds by reading about the Efficient Markets Hypothesis(EMH).
Add the Satellites:
After purchasing the large-cap core, different types of funds—the "satellites"—representing different fund categories will complete the structure of the Core and Satellite mutual fund portfolio. These other funds can include mid-cap stock, small-cap stock, foreign stock, fixed income (bond), sector funds and money market funds. These satellites are the funds that will help the investor, if successful in this strategy, to obtain higher returns than the benchmark, such as the S&P 500. At a minimum, the Core and Satellite structure forms a well-diversified asset allocation to help the investor achieve reasonable returns for reasonable risk.
The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.