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Investors love to take home run swings, and it’s often the high flyers that get the most media attention. While building a broadly diversified, low cost portfolio is generally considered the best way to build long-term wealth, there’s nothing wrong with dabbling in more specialized areas of the market to generate above average returns.
Enter the core-satellite approach to portfolio construction.
One segment of the portfolio is committed to the core strategy of investing in cheap, diversified index funds. This is the portion of the portfolio that generally shouldn’t be traded, and should be regularly added to via investing in a workplace retirement plan, IRA or some other systematic investing program.
The other segment is the satellite strategy, where investors can overweight in specific sectors, regions or styles in an attempt to take advantage of current economic and market conditions to produce outsized returns. This is the actively managed part of the overall portfolio. The advantage of this strategy is that the majority of the portfolio is focused on long-term wealth creation, but still allows for tilting the portfolio to try to outperform the market without taking on too much risk.
Click here to learn about the benefits of portfolio diversification.
Examples of funds that could go into the core part of the portfolio include the Vanguard 500 Index Fund (VFINX), the Vanguard Total Stock Market Index Fund (VTSMX) or a target-date fund that aligns with your future liquidity requirements. A balanced fund that mixes stocks and bonds, such as the T. Rowe Price Capital Appreciation Fund (PRWCX), is another good option.
Again, the core part of the portfolio should generally be left untouched and should only be modified for things such as periodic rebalancing or an allocation change due to an approaching target date. These funds should focus on low costs and broad diversification, as well as matching an index instead of taking unnecessary risks to outperform it.
Learn about the important criteria for selecting a mutual fund here.
If you feel that overseas markets could outperform, you could choose Fidelity International Capital Appreciation (FIVFX) or JPMorgan Emerging Markets Equity Fund (JFAMX). Tech enthusiasts might like something such as the Vanguard Information Technology Fund (VITAX). There are endless possibilities, but it’s still important to keep an eye on fees and risk with satellite products. Funds with a narrower focus tend to come with higher expense ratios and greater risk, so limiting exposure to these funds is advisable.
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