What is a core and satellite investment strategy? (2024)

Core and satellite investing is a powerful way to invest that combines the benefits of passive and active investing.Passive investing is when you invest in index funds, which track a specific market index, such as the S&P/ASX 200.

While, active investing is when you choose individual stocks or actively managed funds to invest in. With core and satellite investing, you invest the majority of your money in passive index funds (ie: the core). You then use a smaller portion of your money to invest in individual stocks or actively managed funds (the satellites).

The debate on both sides over which is better, passive or active, ispassionate.But you can skip the arguing, investing is one of those great realms where it’s not black or white, you can have the best of both worlds.Enter core and satellite.

This approach allows you to get the benefits of diversification and low costs from passive investing, while also having the opportunity to outperform the market with your satellite investments.

What core investments should I hold?

The core is your anchor. The core is made up of passive indexed investments.Below you’ll see a table of the key ETFs that make up the InvestSMART Diversified Portfolios. These are index tracking ETFs which will each give you the average return of the asset class tracked.

To decide the split across asset classes, we take a time-based approach. The longer you have to invest (e.g., planning for retirement in ten years) the higher the allocation to growth assets.

This is as close to a set and forget strategy as you will getand can expect to earnthe long-term average return from holding this group of assets.

The satellite

Your satellite part can be made up of many different things. You may be interested in an actively managed fund for Australian or international shares or small caps. You may wish to invest in emerging markets such as Asia and South America. Maybe you want to invest in some stocks you’ve read up on, or you’ve been issued shares in the company you work for. Or all of the above.

The purpose of your satellite is performance and added diversification. If, over the long term, your satellite investment does not outperform its peer asset class in the core, it is detracting from your portfolio and you can get a better return by taking a passive approach.

How much core and how much satellite?

The amount of money you allocate to core and satellite investments will depend on your individual risk tolerance and investment goals.When it comes to choosing how much to invest, we recommend following the asset class weights of a good, diversified portfolio that is in line with your time frame ie: how long you plan to invest for.

Below you’ll find links of each InvestSMART Diversified Portfolios. Click through and view Asset Allocation & Holdings under the Key Facts section to see the weights of each asset class to use as a guide. For example, if you’re aligned with High Growth, your combined core and satellite Australian equity exposure won’t exceed 34% of your total portfolio.

What are the pros and cons of a core and satellite approach to investing?

With core and satellite investing you can avoid the active vs passive debate entirely and sit smugly in the middle. The issue here is the numbers are on the side of team passive.

• Outperformance isn’t easy or common

Most managed funds and individuals who select their own stocks underperform their passive index counterparts. It’s not a biased opinion, it’s just a fact. Active investing comes at a higher expense in the form of management fees and brokerage fees. And financial markets and economic cycles are unpredictable and on top of this you need to manage your own emotions and make rational decisions. It’s harder than it sounds.

• Time & knowledge

There are more managed fund options in Australia than there are stocks on the ASX. You need to put in time and effort to understand the fund manager's approach. Educate yourself so thatwhen markets become volatile you are comfortable with the manager'sactions.

• Overconfidence

Overconfidence is a bias we all suffer from and you’ll be tempted to put your wealth at risk because of it. In times of market optimism, riskier investments such as small cap stocks and emerging markets can race ahead of less risky passive options.

You’ll be tempted to invest more in these, diverging from your strategy and falling into the trap of recency bias where you extrapolate short-term returns and expect them to continue.

This adds more risk to your portfolio and just as quickly as they can race ahead of passive counter parts on the way up, so too can they on the way down.

• Opportunity cost

Finally, both options come with the potential for opportunity cost. Opportunity cost is the returns forgone by choosing one investment over another. By selecting a 100% passive approach you know you will receive the average return. By choosing an active approach you open yourself up to the possibility of an above-average return.

Remember your timeframe and follow through on it

Just as the InvestSMART Diversified Portfolios have recommended timeframes, so do managed funds. They exist for a reason. If you’re not prepared to hold the investment for the recommended timeframe, regardless of market movements, don’t invest.

Most of us aspire to do better. Average just isn’t good enough. Despite the data being stacked against active investing through our own stock picking or a managed fund, many believe they can outperform, or just want to give it a go. Core and satellite investing gives you that chance but with a safety net.

A common satellite pairing with the InvestSMART portfolios are the Intelligent Investor managed funds. These can be held separately or part of your InvestSMART Professionally Managed Account.