How core-and-satellite approach to equity investing can help retail investors

Picture this: An individual in his mid-50s, with over a decade’s experience dabbling in shares, has barely a 5 percent allocation to equity in his total portfolio. He never created serious long-term wealth in the stock market, despite the secular bull run.

Another investor has a highly concentrated stocks portfolio, comprising 95 percent equity allocation of total investments. He prefers does not prefer to invest via mutual funds and has very little allocation to fixed income instruments.

A third person has 150 shares in her portfolio based on random tips garnered while working in the IT division of a stockbroking firm.

These are my clients whose actual anecdotes I have shared.  And there are many others who inevitably have some investment in stocks, either bought on tips or in initial public offerings or IPOs.

Mistakes retail investors make

I can vouch that in general, most retail investors, including scores who have jumped on the stock market bandwagon in the wake of the COVID-19 lockdown in 2020:

•       Do not have a structured process to invest directly in stocks.

•       Lack adequate diversification in their portfolios, which are not based on solid research.

•       Fail to understand the dynamics of asset allocation and portfolio construction.

•      Are not equipped to handle the high volatility that comes with directly investing in  stocks.

•      Have a tendency to time the markets, which often proves detrimental.

Further, it is difficult to map and align stocks to goal-based planning and to regularly invest in the markets in a disciplined way to accumulate a corpus. How does this sound: Mapping large-cap IT company holdings to a child’s education and mid-cap bank stocks to marriage? Mapping one company or sector to a goal is not practically feasible, unlikely to yield efficient results and is highly risky. In the case of a unified portfolio, which stocks to sell to fund the value of the goal—that is again the hardest decision.

Also read: Reached your financial goal early? Avoid greed for more returns, move to safer investments

In the oft-repeated words of Warren Buffet, ‘We don’t have to be smarter than the rest, we have to be more disciplined than the rest.”

For an average retail investor, a mutual fund is the most suitable and convenient vehicle to invest in equities. A fixed sum can be regularly invested in systematic investment plans (SIPs) in a disciplined manner, notwithstanding the market fluctuations.

This approach is difficult to adopt when the retail investor is vainly trying to time the markets and always engulfed in the dilemma of when to buy or sell. Besides, a fund manager is better placed to invest in a group of stocks, diversified across large-, mid- and small-cap companies and accompanied by a solid research team to offer efficient returns to investors.

Does this imply retail investors should avoid investing directly in stocks?

Also read: This mutual fund facility gives you regular income. Here’s how

The core and satellite approach

Retail investors can effectively manage risk by investing in both stocks and mutual funds through the core and satellite investment strategy. Mutual funds can form the core portion of the equity investments (85-90 percent) which is geared to meet various financial milestones over the long run.

The investor can be disciplined enough to regularly invest in the core portfolio and avoid tampering with it, irrespective of the state of the markets. It can be liquidated only when the goals are nearing completion or the equity portion in the total portfolio has crossed a certain threshold that is beyond the risk-taking appetite.

The balance 10-15 per cent can form the satellite portion of stocks where the investor can bear higher risk and take tactical bets of buying, selling and revolving the same capital in different companies. This will help the investor scratch the speculative itch while at the same time  enabling his core portfolio to compound and grow.

The core-satellite strategy works beautifully, enabling the investor to stay focused and contain the downside risk. After all, successful investing is about managing risks, patiently creating long term wealth and making fewer mistakes along the way.