One of the primary ways a San Antonio wealth advisor can benefit you is to manage your investments with an objective of maximizing return and minimizing risk in the context of your goals. For both your general investment and retirement portfolios, risk management is just as crucial to understanding as returns. At PAX Financial Group, we think that core-satellite investing is a robust way to manage investment risk.
Check out our newest Guide: Core-Satellite Investing in San Antonio!
A Look at Core-Satellite Investing
Core-satellite investing refers to a method in which your investment portfolios are split into two main divisions, the “core” and “satellite.” The core, which makes up from 50 percent to 80 percent of the portfolio, is made up of low-cost passive investments expected to perform well over time. These passive investments can vary widely, from a broad-based U.S. stock index like the S&P 500 to a global bond fund.
The satellites, on the other hand, are actively managed investments ranging from 50 percent to 20 percent. The satellites can be used for several different purposes, including enhancing investment returns and managing risk.
Now that you are aware of what core-satellite investment is, let’s look at how it helps to manage investment risk specifically.
Number 1: It Diversifies Your Portfolio to Protect Against Market Risk
The term “market risk” refers to the possibility of losses in your investments. One of the key ways in which a financial advisor can protect against market risk is to diversify your portfolios, taking into account your risk tolerance, situation, goals, and other relevant factors, such as your age.
All asset classes have a risk-reward profile. Stocks, for example, are relatively high risk because the stock market is volatile, with prices fluctuating up and down constantly. But stocks are also high reward because, over the last century, U.S.-based stocks have returned 10 percent per year on average, even accounting for periodic downturns.
Bonds, by contrast, are relatively low risk, but also relatively low reward. The price fluctuates in inverse correlation to interest rates and will fall if interest rates rise (and rise if they drop). But those price fluctuations are usually significantly less than potential losses in stock market pullbacks. Bond instruments offer yields as well, which can also fluctuate over time.
Cash is very low risk because the price of certificates of deposit and other cash instruments does not change. Cash is also, however, low reward because interest rates over the past 15 years have been quite low.
Because of these varying risk-reward profiles, many portfolios are diversified among the three. Bonds and cash provide stability and growth from compound interest (and some price appreciation potential, in the case of bonds), which counterbalance any potential risk from drops in the stock market. Stocks provide appreciation potential above that of bonds and cash, counterbalancing the risk of low growth in bonds and cash.
Core-satellite investing can be used to diversify the asset classes in your portfolio. The satellites can be placed in cash or bonds if the core is in stocks, for example. If the core is in bonds, the satellites can be placed in cash or stocks.
Number 2: It Protects Against Other Types of Risk
Market risk is but one type of risk that your PAX Financial Group financial advisor is concerned with protecting against. Your portfolio can be threatened by several other types.
The first is inflation risk. Inflation is the measure at which prices rise. Over time, rising prices will erode the value of your portfolio. While the amount may be the same, you can purchase less with it.
Inflation in the U.S. has over the past several decades grown at an annual rate of 2 percent. However, over the last several years, it has been much higher than that. The rate of inflation must be protected against in your portfolios, or it can outpace investment gains, and you can end up with much less purchasing power – something that can especially affect retirement portfolios.
An actively managed satellite can protect against inflation risk by choosing asset classes and choices within them that are expected to outperform the pace of inflation.
The second is interest rate risk. Interest rate risk refers to the potential of market losses when interest rates rise or fall. The price of bonds, for example, will fall if interest rates rise. Satellites can be used to protect against interest rate risk. Wealth managers do this by investing in several different bonds with variable maturity dates and potentially by using interest rate derivatives.
Number 3: Is Flexible to Respond to Variable Risks
The third way in which core-satellite investing can help manage risk is its flexibility. The satellites can easily be customized to adapt to changing levels of risk or changes in your life and goals that make you vulnerable to risk.
Political uncertainty, for example, can make markets riskier. If your satellites have been invested in emerging markets (a high reward/high risk sector), for example, the investment can be changed to a lower risk investment if those areas became more volatile.
The satellites can also be customized as your life changes. As you move toward retirement, for instance, you and your financial advisor may feel that your assets should be changed to a lower risk/lower reward profile. The chances of a drop in value are far more significant for someone planning to retire relatively soon than for someone in their 20s or 30s because they have several decades to recoup any losses. Those in pre-retirement and retirement need to conserve their assets, usually, rather than focusing on aggressive growth. Core-satellite investing is a streamlined way to make your portfolios match your goals and life situation over time.
PAX Financial Group: A Comprehensive Financial Advisor in San Antonio, TX
PAX Financial Group offers comprehensive financial planning, including wealth management (investments), cash management, tax planning, risk management (insurance, and estate planning. All of our planning is done in concert with your personal goals. We are fiduciaries who always put your best financial interests before our own. Contact us to meet either by phone or in our convenient San Antonio, Texas office.
