Advice abounds about keeping a ‘core’ portfolio and building around it.
But how do you actually set up a core-satellite portfolio? Here’s explaining the process.
Investment processIt is important that you adopt the process explained in its entirety to effectively apply the core-satellite framework.
First, create a separate account only for investments. This will receive automatic monthly debits (savings) from your “regular” savings account to which your income is credited. The purpose of the “investment” savings account is to have a master account to route all your savings into appropriate investments. Systematically transfer money from this account into equity mutual funds, ETFs, fixed deposits and real estate. Second, each significant life goal should have a separate demat account. These life goals include funding your child’s education, buying a house and saving for retirement.
The demat account for education should be in your child’s name and that for retirement in your name. The other life goal (buying a house or an exotic vacation) should be in the name of your spouse.
These demat accounts should be linked to a core portfolio earmarked for that particular life goal. So, your retirement demat account will have only those investments which are earmarked for retirement.
Such a mapping of your demat account with the financial goal is important because the risks you can bear for each goal are different.
The risk you can assume depends on the priority of each life goal and the distance to the investment horizon. Risk-taking ability is low on top-priority goals, while it is high when the distance to investment horizon is farther. Having separate demat account helps because risk-taking ability drives your rebalancing process.
Third, every portfolio has to be rebalanced periodically, as the actual annual return on investments will be different from expected return.
If the actual return is higher, you should sell some equity and move to fixed deposits. If the actual return is lower, you should contribute more capital to the portfolio. The rebalancing decision is a function of your risk-taking ability.
If investments mapped to high-priority life goals lose significant value, you may want to move the rest of the investments to fixed deposits to protect further deterioration in value.
Separate demat accounts will help you to apply the hierarchy-fungible rule. This will apply when you face shortfall in a specific portfolio at or near the end of that portfolio’s investment horizon. Suppose you need ₹40 lakh in your child’s education and you only have ₹30 lakh a year before your child enters college.
You can transfer ₹10 lakh from your retirement savings account if it has a lower priority than the education account. Transferring investments through separate demat account leaves trail for audit. You need to have another demat account only for your satellite portfolio. This account will carry investments to capture short-term gains in the market.
You can invest through a systematic plan and sell using a rule-based approach or you can apply technical analysis to buy-sell shares continually.You should preferably operate all demat accounts through the same bank for convenience. Operating separate demat account for each life goal can also make it easy for your spouse to understand and appreciate the investment process.
The writer is the founder of Navera Consulting. Feedback may be sent to portfolioideas@thehindu.co.in