Creating a satellite portfolio is just as important as setting up a goal-based portfolio. In this article, we discuss why a satellite portfolio is an essential part of your total investments. We also show how you can create such a portfolio.

Bridging gaps

You should set up a satellite portfolio to capture short-term gains primarily in equity and commodities markets. While the time horizon for such a portfolio is typically less than three months, you should not hesitate to hold your position longer.

To appreciate the relevance of a satellite portfolio, picture a world where you have only goal-based portfolios. What if the stock market rises 40 per cent in three years only to decline 30 per cent in the fourth year? Your core portfolio would have lost all its unrealised gains. Why? When you create a goal-based portfolio, you determine your required return — called the minimum acceptable return (MAR) — based on the amount of savings and the time horizon for your life goal.

Typically, MAR is based on pre-tax expected return of 12 per cent on equity and 7 per cent on bonds, with appropriate tax rates. Importantly, MAR is a compound annual return. This means you have to leave the pre-tax unrealised annual gains of 12 per cent in your portfolio.

If you take profits and reinvest the proceeds in bonds, you will earn a lower return than your MAR. And that could lead to failure of your life goals.

Now, back to our example. If your investment earns 40 per cent in three years, you have earned unrealised compound annual returns of 12 per cent, which is also your expected return. So, you have to keep all your unrealised gains in the portfolio to compound the next year. But the market declined 30 per cent in the fourth year, wiping out all the unrealised gains. This means you have lost three years of MAR, which your portfolio has to catch up in the remaining years to meet your goal. That is, indeed, a difficult task.

This is where your satellite portfolio comes handy, as it is geared towards capturing asset price movements in volatile markets. Needless to say, the gains you make in this portfolio can be used to bridge any value-gap in your core portfolio.

Satellite management

You can also use the gains from the satellite portfolio for non-budgeted discretionary spending such as unplanned vacations or buying luxury products. Then, there is the behavioural factor. You get the excitement and the satisfaction of timing the market.

Suppose you buy a stock at 100 and sell it at 160. You feel happy that you made 60 per cent return on your trade. Your happiness is even more when the stock you sold subsequently declines.

Of course, you will also have your fair share of regrets. But that is the trade-off.

You should use technical analysis to time your trades in your satellite portfolio. If you do not know how to read the charts, you can buy professional research reports till you learn technical analysis.

Planning your own trades can be more exciting than acting on someone else’s advice.

Also, it is behaviourally optimal to attempt and fail (at technical analysis) than not try at all.

Your satellite portfolio should not be more than 40 per cent of your total investment portfolio. That is, if your total investment is worth ₹50 lakh, your goal-based portfolio should be at least ₹30 lakh and your satellite portfolio not more than ₹20 lakh. This rule ensures that you do not become a compulsive trader at the expense of sacrificing your life goals.

You must, therefore, take profits and invest in bank deposits when your satellite portfolio’s allocation is more than 40 per cent.

This also enables you to create necessary buffer capital for your goal-based portfolio.

The writer is founder ofNavera Consulting.Send your feedback to portfolioideas@thehindu.co.in

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