The “Best Of Both Worlds” Investing Strategy

The “Best Of Both Worlds” Investing Strategy
Milou Beunk

over 2 years ago4 mins

  • The stock market has had a pretty good run since April last year, and that might trick you into thinking gains are easily had...

  • ... But things are different this year: if you don't have a strategy, you could lose out or lose big.

  • A core-satellite investment approach should set you up for long-term gains.

The stock market has had a pretty good run since April last year, and that might trick you into thinking gains are easily had...

... But things are different this year: if you don't have a strategy, you could lose out or lose big.

A core-satellite investment approach should set you up for long-term gains.

Mentioned in story

What’s going on here?

With stock markets near record highs in the US, you’ll probably need to be more selective if you want to make money in the second half of 2021. Lacking a strategy could leave you liable to losing big; luckily, however, I’ve got a suggestion that could instead set you up for long-term investment success.

What does this mean?

Before getting into the details, I want you to bear in mind three principles that I consider to be crucial for any long-term investor – some of which might surprise you:

Deciding whether you’re in stocks, bonds, or cash is more important than deciding which stocks or bonds to invest in

One famous study suggested the former decision may account for up to 90% of your investment gains. While the actual percentage is hotly debated, most professionals agree that the vast majority of returns are due to appropriate asset allocation, rather than shrewd investment selection within those asset classes.

The factors behind long-term portfolio outperformance
The factors behind long-term portfolio outperformance (Source: Vanguard)

It’s hard – if not impossible – to consistently pick stocks that do better than the broader market

While stock-picking is arguably a lot more exciting than investing in exchange-traded funds (ETFs) that simply track an index, it’s very difficult to do consistently well. Again, this is a topic that attracts vocal advocates on either side – but hard data appears to demonstrate that the effort involved in stock-picking rarely pays off in the long run.

Time in the market is more important than timing the market

We’ve said it before: timing the market is notoriously difficult. Thing is, you needn’t bother. Analysis from Capital Group, one of world’s biggest investment managers, shows timing isn’t critical to long-term success: regular investing is. If you’d consistently reinvested in US stocks once a year for the last two decades, your portfolio would have gained 7% annually on average – even if you always picked the very worst day to invest (i.e. when the market was at its highest).

Why should I care?

Armed with these lessons, allow me to introduce you to a technique which I think could hold the key to long-term investment success: the core-satellite approach. With the outlook for stocks this year uncertain, embracing the “best of both worlds” could give your portfolio a structure sufficient to protect you from dangerous levels of risk. There are two parts to this:

  • A core of “boring” low-cost ETFs that give you diversified exposure to broad stock and bond markets. This element requires very little time and effort. The goal is simply to stay invested – remembering that time in the market is important and that it’s difficult to beat said market in the long run.
  • A satellite of more individualistic and insightful (and short-term) trading ideas. With this part of your portfolio, you’re either trying to pick investments that will outperform the broader market or accurately time certain segments and sectors.

So how would you set this up in practice? As a rule of thumb, you might want to split your portfolio up 80% core and 20% satellite. Keep the core simple: stocks and bonds in a ratio dependent on your age. The younger you are, the more you can afford to lean towards riskier stocks; some suggest you should subtract your age from 100 and then invest that percentage of your portfolio in stocks.

And as for which stocks to put in the core: buy ETFs tracking the world’s biggest indexes, like the US S&P 500 and European Stoxx 600, or else the global developed-market MSCI World Index. With bonds, buy shorter-term government bonds (or equivalent ETFs) in the currency of your home country.

And what goes into the satellite? Why, your best investment ideas, of course – perhaps with a nudge or two from your friendly Finimize analysts…

The core-satellite approach won’t necessarily be to everyone’s taste. But it’s based on some pretty solid investment wisdom – and could create the sort of balanced, low-fuss portfolio that’s just the ticket for potentially turbulent times ahead. And there’s nothing wrong with keeping things simple. After all, legendary investor Warren Buffett recommends just two investments for the trust in his will: 10% in short-term government bonds and 90% in a cheap S&P 500 tracker…

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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