What is Mutual Fund Core and Satellite Investing?

Building a Core and Satellite Mutual Fund Portfolio

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When building a portfolio of mutual funds, the simplest design happens to be the best. In this article, investors will be introduced to the basics of portfolio construction with a design called "core and satellite." Like many of the best investing strategies and philosophies, core and satellite is simple and effective, especially for long-term, buy-and-hold investing.

Definition of Core and Satellite Portfolio

Core and Satellite is a common and time-tested investment portfolio design that consists of a "core" investment, such as a large-cap stock index mutual fund, which represents the largest portion of the portfolio. The other types of funds—the "satellite" funds—each represent a smaller portion 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 Apple, Wal-mart and Microsoft, is so readily available to the public that it is extremely difficult for investors to gain an advantage on other investors, thereby consistently out-performing the market averages, 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, and perhaps most importantly, the Core and Satellite portfolio construction design can help insure investors are well-diversified among different asset types (stocks, bonds and cash) and different mutual fund categories. This asset allocation and investment makeup can also help the investor achieve reasonable returns for reasonable risk.

Disclaimer: 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.