Many investors spend most of their time worried about picking individual stocks that will beat the market. While you might be able to choose a few winners every once in a while, you’d have to be some Wall Street prodigy to do it regularly.
Research shows that even mutual fund managers have struggled to pick individual stocks to beat their peers consistently. Only 39% of professional fund managers beat the average fund performance in 2012, and most underperformed the market when accounting for fees.
If you can’t beat the market, you might be tempted to ‘join it’ by investing only in broad index exchange-traded funds (ETFs) like the SPDR S&P 500 ETF (SPY), which invests in the overall market.
But just investing in the market means your returns will be limited, especially after paying fees and Uncle Sam takes his share. Fortunately, an investment strategy offers the best of both worlds, easy index investing with the chance for higher returns on a few standout stocks.
I call it my sleep-at-night investing strategy, but most know it as core-satellite investing.
The Core Satellite Investing Strategy
A core-satellite investing strategy means investing most of your money (the 60% to 80% core) in broad funds and the rest of your money around individual stocks. The core portion of your portfolio exposes you to the entire market, reduces your overall risk, and limits your loss to fees. The satellite portion of your portfolio allows you to pick a few winning stocks and put your market analysis to work.
Most broad index funds invest passively across hundreds or thousands of companies and infrequently change investments in the fund. This means annual management fees as low as 0.20% of your investment. Beyond the core portion of your portfolio, you only need to choose about 10 to 20 individual stocks for the satellite portion of the investing strategy.
By only investing a small portion of your portfolio in a few individual countries or companies, you cut down on the research and analysis you need to do, and the amount of time it takes to monitor your stocks for changes. The core portion of your portfolio is a buy-and-hold investment that requires no monitoring. The satellite portion of investing strategy may involve some research to pick your favorite stocks but minimal maintenance if they are long-term picks.
Even with a core-satellite investing strategy, it’s best to take a long-term view. Trying to time the market and trade in and out of your stocks will mean that fees eat into your returns. Even just picking a handful of stocks for the satellite portion of your portfolio can get a little expensive if you’re investing multiple times a year. One newer online investing site, Motif Investing, helps to cut costs by letting you group individual stocks into a fund and buy them all with one commission. You essentially create your own exchange-traded fund with your individual picks. You can create a fund with up to 30 stocks and then pay one fee of $9.95 to buy them all.
How to Set up a Core Satellite Investing Strategy
Setting up the core portion of your core-satellite investing strategy is pretty easy. You want to choose three to five broad-based ETFs that will expose you to the larger market. All funds will give a percentage breakdown of the type of stocks held and the fund’s focus on its website. Don’t forget to choose funds that will expose you to large and small companies and foreign companies. You don’t have to buy an equal amount of each fund. You might want to buy more of a fund that gives you complete stock market coverage and then buys smaller amounts of a few other funds.
Some exchange-traded funds to consider for your core-satellite investing strategy:
Vanguard Total World Stock ETF (VT) might be the broadest fund available, providing access to 7,391 stocks across the globe. The fund charges a management fee of just 0.17% annually and spreads investments across countries and different size companies.
SPDR S&P 500 (SPY) is what most people think about when they think of the stock market. The fund invests in 500 of the largest and most stable companies in the United States and charges a super-low of 0.11% annually.
Vanguard REIT ETF (VNQ) might be part of your real estate investing strategy, but I had to mention the fund. It’s an excellent resource for investors, providing access to 144 companies that invest and manage real estate properties. These companies pass almost all their profits to investors each year, making the dividend extremely attractive, and the fund charges just 0.12% annually.
iShares MSCI Emerging Markets (EEM) invests in 846 companies and more than 15 of the fastest-growing counties in the emerging world. The management fee of 0.68% is a little higher than other broad market funds, but it’s essential to have exposure to these countries and companies that should beat slower growth economies over the coming decades.
For a complete review of the regions, countries, and stocks in emerging market investing, check out my new book Step-by-Step Emerging Market Investing. The book builds the case for why everyone needs to invest in the emerging theme and helps you develop a strategy that fits YOUR goals.
You don’t need to be a stock market genius to pick stocks that can do well over the long term. For the satellite portion of my portfolio, I like to look for stocks with the power of long-term trends behind them. These companies will benefit from overwhelming market forces like demographics, tech trends, and population needs.
One example is my individual investments in fertilizer and other agriculture-related companies. Record harvests and the El Nino weather phenomenon have driven crop prices to multi-year lows, but there’s little doubt of the massive long-term demand for grains and other crops. Stock prices of fertilizer companies and seed suppliers are lower now but will benefit significantly over the next couple of decades on rising population demand for food.
Besides using Motif Investing to buy your individual stocks, you could use it for your entire core-satellite portfolio. Since ETFs are traded like stocks, you can include them in your motif funds and buy everything with just one commission. Construct a core-satellite portfolio with five funds and 15 individual stocks and pay just $9.95 to buy them all and then $10 each time you want to invest more money into your portfolio.
The core-satellite investing strategy is one of the most efficient tools for setting up your investments. The strategy gives you the confidence and ease of buy-and-hold index investing. You’ll benefit from the general upward direction of the stock market without worrying about constantly picking winning stocks. You’ll also benefit from long-term trends in individual stocks and a chance to beat your investment goals without spending every waking hour reading stock analysis.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.