How core and satellite approaches to stock investing can help individual investors

Imagine this. An individual in his mid-50s who has been dabbling in stocks for over 10 years allocates just 5% of his total portfolio to stocks. Despite the secular bull market, he never made any significant long-term wealth in the stock market.

Another investor has a highly concentrated stock portfolio with 95% of his total investment allocated to stocks. He doesn’t like investing in mutual funds and has little allocation to bonds.

A third person has 150 stocks in his portfolio based on a random tip he received while working in the IT department of a brokerage firm.

These are my clients with whom I have shared real-life anecdotes. There are also many people who necessarily have some investment in chips, initial public offerings, and stocks purchased in IPOs.

Mistakes made by individual investors

In general, we can safely say that most retail investors, including many who jumped on the stock market bandwagon in the wake of the 2020 coronavirus lockdown, will:

• There is no structured process for investing directly in stocks.

• The portfolio lacks sufficient diversification and is not based on solid research.

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

• We are not equipped to handle the high volatility associated with investing directly in equities.

• Tends to time the market, which often proves harmful.

Moreover, it is difficult to map and adjust stocks to a goal-based plan and accumulate a corpus by investing regularly in the market in a disciplined manner. What do you think about mapping holdings in large IT companies to children’s education and mid-cap bank stocks to marriage? It is not realistically possible to map a single company or sector to a goal, It is highly risky and unlikely to yield a positive result. For a unified portfolio, the most difficult decision is also which stocks to sell to cover the target value.

Read also: Have you achieved your financial goals early? Avoid greed for more profits and move towards safer investments

As Warren Buffett often repeats, “We don’t have to be smarter than everyone else. We just have to be more disciplined than everyone else.”

For the average individual investor, mutual funds are the best and most convenient way to invest in stocks. Despite market fluctuations, you can invest a fixed amount regularly in a systematic investment plan (SIP) in a disciplined manner.

This approach is difficult for individual investors to adopt if they are trying to time the market in vain and are constantly caught in the dilemma of when to buy or sell. Moreover, the fund manager is well-suited to invest in a group of stocks that are diversified into large, medium and small-sized companies and accompanied by a strong research team to provide efficient returns to investors.

Does this mean that retail investors should avoid investing directly in stocks?

Also read: This mutual fund scheme gives you regular income.Here’s how to do it

Core and satellite approach

Individual investors can effectively manage risk by investing in both stocks and mutual funds through core and satellite investment strategies. Mutual funds form the core (85-90 percent) of equity investments and are aimed at achieving various financial milestones over the long term.

Investors can invest regularly in their core portfolio and be disciplined enough to avoid tampering with it, regardless of market conditions. You can only liquidate if you are close to achieving your goals or if the equity portion of your overall portfolio exceeds a certain threshold beyond your willingness to take risks.

The remaining 10-15 percent forms the satellite portion of the stock, which allows investors to take higher risks and make tactical bets to buy, sell, and rotate the same capital in different companies. This helps the investor get rid of the speculative itch and at the same time allows him to compound and grow his core portfolio.

The core-satellite strategy works beautifully, allowing investors to stay focused and limit downside risk. At the end of the day, investing success is about managing risk, being patient, building long-term wealth, and making fewer mistakes along the way.