Core-satellite approach: A smarter way to diversify your investments

Benefits of the core-satellite approach

The core-satellite approach offers multiple advantages, making it a versatile and effective strategy for modern investors. Here are the main advantages we hope you will keep in mind when considering if this is the right strategy for your goals.

Broad diversification

This strategy reduces the risk of underperformance by spreading investments across diverse asset classes, sectors, and geographies. The core holdings ensure stability, while satellite assets provide exposure to emerging markets, niche industries, or alternative investments. Diversifying in this way minimises the impact of downturns in any single segment, supporting consistent performance.

Cost efficiency

Passive investments in the core are inherently low-cost due to minimal trading and management fees. These savings impact long-term returns, especially when compounded over years. Satellites can introduce higher costs, but keeping their allocation small ensures the overall portfolio remains cost-efficient. Combining the two enables investors to optimise returns without overpaying for management fees.

Potential for outperformance

Satellite investments are designed to target opportunities beyond benchmark performance. By focusing on market trends, inefficiencies, or high-growth sectors, the satellite portion can improve return potential. For example, actively managed funds targeting renewable energy or emerging technologies could potentially deliver superior results, complementing the steady gains from core holdings.

Stability during market volatility

The core portion acts as an anchor during periods of market turbulence. Index funds or ETFs tracking broad benchmarks like the S&P 500 or FTSE 100 provide steady returns, offsetting losses in higher-risk satellites. This stability ensures that the portfolio remains resilient, even when satellite investments face short-term challenges.

Flexibility for customisation

One of the most attractive features of the core-satellite strategy is its ability to be customized. Investors can tailor the mix of core and satellite investments to match their unique goals and risk appetite. Conservative investors may lean toward an 80-20 allocation, prioritising stability, while aggressive investors might opt for a 60-40 split to capture greater growth potential.

How to build a core-satellite portfolio

Creating a core-satellite portfolio requires planning and thoughtful consideration to align with your financial goals and risk tolerance.

Follow these steps to create a balanced and effective portfolio:

1. Assess your risk tolerance and goals

Begin by defining your investment objectives and risk appetite. Determine whether your priority is long-term growth, income generation, or wealth preservation. Understanding your financial goals helps you decide the appropriate allocation ratio between the core and satellite components, such as a conservative or a more aggressive split.

2. Select core investments

The core portion should consist of passive, low-cost investments that provide stability and broad market exposure. Options include index funds and ETFs tracking benchmarks like the FTSE 100 or S&P 500. These holdings form the foundation of your portfolio, delivering steady returns and reducing overall volatility.

3. Add satellite investments

The satellite portion enhances growth potential by targeting specific sectors, regions, or themes. Consider actively managed funds, thematic ETFs, or individual stocks aligned with market trends or emerging opportunities, such as renewable energy, technology, or small-cap equities. Keep the satellite allocation smaller to manage risks effectively.

4. Decide your desired allocation

Choose an allocation ratio that reflects your risk tolerance and investment strategy. For instance:

• 80-20 for conservative investors. Focus on stability with limited exposure to high-risk assets.
• 70-30 for balanced portfolios. Combine steady growth with moderate risk-taking.
• 60-40 for aggressive investors. Prioritise growth opportunities with higher exposure to volatile markets.

5. Monitor and rebalance regularly

Market fluctuations can change your portfolio's allocation over time, impacting its alignment with your goals. Periodic reviews can help you maintain the desired balance between core and satellite components. Rebalancing ensures your portfolio stays on track and continues to meet your risk and return objectives.

6. Manage costs

Keeping your fees low can maximise your portfolio's efficiency. Opt for low-cost passive funds in the core and consider tax-advantaged accounts or strategies to optimise returns. Reducing unnecessary expenses ensures that more of your investments work toward your investment goals.

Conclusion: Balancing stability and growth in your portfolio

The core-satellite strategy combines stability with growth potential, creating a versatile framework for modern investors. With a foundation of low-cost core investments complemented by targeted satellite holdings, this approach helps balance risk and reward effectively.

This strategy adapts to a variety of goals, making it suitable for all kinds of investors. Regular portfolio monitoring and rebalancing can ensure the approach remains aligned with your objectives, offering a dynamic yet realistic and grounded approach to diversification.