What Is Mutual Fund Core-and-Satellite Investing?

Definition and Example of Mutual Fund Core-and-Satellite Investing

Core and satellite is a common, time-tested portfolio design that is made up of complementary investments. It is structured around a "core" asset, such as a large-cap index fund, which makes up the largest portion of the portfolio. Smaller funds, known as "satellite funds," round out your portfolio and create the rest of your investments.

For example, you might pick a single large-cap stock fund and invest 30% to 40% of your portfolio in it. You would then fill in the remaining 60% to 70% of your portfolio with many smaller investments in other funds or assets.

The goal is to achieve above-average returns with below-average risk. Using this type of design, the satellite assets provide diversification, which reduces your risk, while the core asset brings in a large share of your earnings and growth. Your overall portfolio should outperform a standard benchmark for performance, such as the S&P 500 Index.

The core-and-satellite approach is for long-term investors who are interested in growing wealth over time rather than making many frequent trades. It stops you from trying to pick "winning" stocks. It lessens management and commission fees. It also gives you greater diversification in your portfolio.

How Core and Satellite Investing Works

One of the first things new investors learn about is the value of diversification. It's vital to asset classes, sectors, and markets, and it helps to protect you when one investment is declining. One of the simplest ways to achieve it is through mutual and index funds. The core-and-satellite strategy aims to help you do so.

Funds are the best means to invest for most people. They take away from the time and research that's often needed to pick good individual stocks. Funds allow for one purchase to cover multiple investments, because a mutual fund will hold a variety of related stocks. It's potentially a win-win. You can get many investments without looking into individual companies, which gives you instant diversification.

You will also see lower commission costs, because your portfolio will have lower turnover, which means fewer purchases. You can have even lower costs if you decide to invest in index funds. Their management fees tend to be much less than those for funds that are actively traded.

Your Core Holding

Your core holding will often be a diverse large-cap stock fund, such as a low-cost S&P 500 index fund. The S&P 500 consists of the largest 500 U.S. companies, which tend to drive the market. The S&P 500's annual return has been roughly 15% over time, which is a nice percentage for long-term investors.

Large-cap funds make good core positions, because these are often larger companies that have shown that they can thrive through economic downturns. They tend to increase their value over time. There can be price volatility, like with any stock, but they provide the best stability and consistency if your focus is on the long term.

Your Satellite Holdings

Your satellites represent fund categories that will complete the core-and-satellite structure. These other funds can include mid-cap stocks, small-cap stocks, foreign stocks, fixed-income bonds, sector funds, gold, and money market funds. These are the funds that can help you obtain higher returns than benchmarks like the S&P 500.

A mutual fund core-and-satellite portfolio could be made up of:

• One large-cap fund at 40%
• One mid-cap fund at 25%
• One small-cap fund at 10%
• One international fund at 15%
• Bonds taking up 5%
• Cash taking up 5%

This core-and-satellite design can help ensure that you're well diversified among asset types and fund categories. It also can help you achieve reasonable returns for reasonable risk.