Don’t be too concerned if the term “core-satellite investment strategy” is new to you. They are new to many investors who are still relying on obsolete investment tactics in modern times. An easy way to understand the concept is to think of it like building a custom home. First, you lay a solid foundation to support the entire structure, and then you design the layout and features to fit your specific needs. The foundation is the core features, and the layout is the satellite features.
This modern approach to managing money combines stability with flexibility to create something uniquely suited to your goals and tolerance for risk—the two most important features of this investment strategy.
As a unique San Antonio wealth management firm, we help affluent individuals and families protect their assets by developing comprehensive core-satellite investment strategies based on their personal risk parameters. These strategies help them pursue their financial goals throughout their working and retirement years.
In today’s blog, we’ll look at how ETFs can play an important role in a core-satellite investment strategy to protect and nurture what you’ve worked so hard to accumulate.
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Why ETFs Are Ideal for Core-Satellite Portfolios
ETFs have become increasingly popular, especially within the core-satellite investing approach. Here’s why:
- ETFs generally have much lower expense ratios than most mutual funds. This makes them ideal for a portfolio’s core and satellite portions. In a core position where you aim for market rates of return, minimizing fees is crucial for maximizing long-term growth. For the satellite positions, lower costs give you more flexibility to explore niche investments without eroding returns by incurring higher expense ratios.
- Due to their low turnover rates, ETFs are more tax-efficient than mutual funds. Mutual fund redemptions often trigger capital gains distributions passed on to shareholders. On the other hand, ETFs are structured so that individual redemptions don’t impact other investors, reducing the likelihood of unexpected taxable events. This can significantly affect your wealth management strategy when planning for long-term tax efficiency in San Antonio.
- ETFs are typically more transparent than mutual funds, disclosing their holdings daily. This allows you and your financial advisor in San Antonio, TX, to monitor your portfolio more closely and make informed adjustments.
- Unlike mutual funds, which only trade at the end of the day, ETFs can be bought and sold throughout the day. In other words, they trade just like stocks. This can be advantageous when making satellite investments, allowing you to act quickly on emerging market trends or sector opportunities.
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How to Build Your “Core” Investments
In a core-satellite investment strategy, your core holdings should serve as the foundation of your portfolio. They should provide stability, long-term growth, and broad diversification, which makes up the largest portion of your portfolio—typically around 60-80%.
The core is designed to be low-cost and diversified, with a goal of weathering market fluctuations over time, while your satellite investments offer higher risk and reward potential.
Core holdings are diversified portfolios invested in multiple asset classes (stocks, bonds), global investments, and more conservative blue chip stocks. If the S&P 500 is up 10%, your core holdings should be up by a similar amount.
Since core holdings are generally held for the long term, they are structured to grow steadily over long periods. They provide a reliable base of capital appreciation that doesn’t require constant monitoring or frequent changes.
Most core holdings are also low-cost investments, such as passively managed ETFs. Low fees help maximize returns over time, especially in portfolios with long-term investment horizons, where costs can significantly impact performance.
Diversification across multiple asset classes also helps spread risk and reduces exposure to any single economic sector or investment. This makes the portfolio more resilient during market downturns and helps minimize losses when offsetting gains occur.
Lastly, core holdings are typically lower-risk investments, providing a buffer against the higher-risk exposure of satellite investments. This balance helps manage the overall risk level of the portfolio, aligning it with your long-term goals and capacity to take risks..
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ETFs as Satellite Investments
While the core of your portfolio offers stability, the satellite portion is where you can seek higher incremental returns by making more tactical investment decisions. ETFs provide a flexible way to explore niche markets, sectors, or asset classes without locking yourself into long-term, less liquid investments.
For example, if you believe the technology sector is poised for growth, you could use a sector-specific ETF for your satellite investment. Similarly, if you’re interested in international markets, a variety of country-specific or region-specific ETFs are available for investment.
The flexibility of ETFs makes them well-suited for satellite positions in a core-satellite investing approach. Whether you’re targeting commodities, emerging markets, or specific industries, ETFs provide cost-effective and liquid options for diversifying your portfolio even more.
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Comparing Fees: ETFs vs. Mutual Funds
One of the biggest advantages of using ETFs in a core-satellite portfolio is their substantially lower fees than most mutual funds. Mutual funds are actively managed and often come with higher expense ratios, ranging from 0.50% to 2.00% or more. In contrast, many ETFs, especially those that track major indices, have expense ratios as low as 0.03% to 0.10%.
Let’s look at an example. Suppose you’re investing $100,000 in a core position, split between an S&P 500 index mutual fund and an ETF. If the mutual fund has an expense ratio of 1% and the ETF has an expense ratio of 0.05%, the difference in fees over 10 years can be significant. In this scenario, the mutual fund could cost you about $10,000, while the ETF would only cost around $500 over the same period. This could result in considerable cost savings over longer periods.
Tax Implications of ETFs vs. Mutual Funds
Tax efficiency is another area where ETFs have a clear advantage. Mutual funds are structured so that capital gains distributions are passed on to all investors, even if they haven’t sold shares. This can result in unexpected tax liabilities, particularly in years when the fund manager sells a significant portion of the portfolio.
ETFs, by contrast, use a unique “in-kind” creation and redemption process that minimizes capital gains distributions. This makes ETFs a far better option for taxable accounts, as they are less likely to trigger capital gains taxes for shareholders. For high-net-worth investors working with a financial advisor in San Antonio, this tax efficiency can be a key factor when considering structuring a core/satellite investment portfolio.
Why PAX Financial?
At PAX Financial Group, we focus on more than just numbers. While your investments and finances are important, what truly matters is the bigger picture of financial security for the rest of your life. Our goal is to be the engine that helps you pursue all of your life’s goals, not just your financial ones.
Here’s what you can expect when we work together:
- Honest and open conversations with our clients
- Serving you, not just managing your portfolio
- A proven and reliable wealth management process
- Upholding integrity, transparency, and accountability in everything we do
- Acting as financial stewards, always keeping your best interests at heart as fiduciaries
- Offering a clear and straightforward fee structure
If you’re considering the core-satellite investing approach and want guidance on selecting the right ETFs for your portfolio, contact our financial advisors in San Antonio, who can help you make strategic choices that align with your goals. Connect today.
