You will be able to set the share of your portfolio for stock picks and explain why the rest stays indexed.
After eleven modules, Marcus can read an annual report, build a model, value a company and size a position. The obvious next thought is to do more of it: more stocks, more of the portfolio in his own picks. Before he does, his own numbers have something to say. Over five years his time-weighted return beat his benchmark by about 0.15 points a year, and over ten years his Sharpe ratio trailed it, so while the skills are real, the evidence that they've added return isn't there yet.
This module puts the whole portfolio together, counts what running it costs and compares the result honestly with a managed alternative. It starts with the structure most professionals use to fit stock picks beside index funds.
A core and satellite portfolio splits your money in two. The core is a set of low-cost index funds that carries most of the money and most of the long-term growth. The satellite is a smaller part where you hold individual stocks or other active choices.
The core is built from your allocation, the split between shares, bonds and cash that Build and run an ETF portfolio sets in lesson 1.3, Set your split from horizon, need and nerve, and writes into a policy in lesson 8.1, What goes in an investment policy statement, and this course doesn't repeat that work. Marcus's allocation of 80% shares and 20% bonds and cash came from there, and so did his blended benchmark.
Marcus's core today is his world ETF, STI ETF, SGD bond fund and T-bills: S$151,000, about 75% of his portfolio. His satellite is his four single stocks, the bank, the chip designer, the S-REIT and Larkspur, totalling S$51,000, about 25%.
The satellite needs a cap for the same reason a single stock does. Your picks can underperform for years, and if they're a large part of the portfolio, a bad run moves your whole retirement plan.
Consider the arithmetic with made-up figures. Suppose the satellite trails the core by 5 points a year for five years, a bad but not unusual run for a handful of stocks. With a 20% satellite, that costs the portfolio about 1 point a year. With a 50% satellite, it costs about 2.5 points a year, and over five years the gap compounds into roughly an eighth of the portfolio's value. The core is what keeps a stretch like that survivable.
The cap also limits the hours you spend. Lesson 12.5, Price your hours: what your research time costs, shows that most of the time Marcus spends on investing goes into his stocks, with his funds taking only a few hours a year.
How big should the satellite be? The tempting answer is "as big as my confidence", and the better one is "as big as my record justifies".
Marcus's record is the returns tab from lesson 1.8, Build the returns tab of your investment workbook, and the risk dashboard from lesson 2.8, Build a risk dashboard for your portfolio and two benchmarks. Over five years his time-weighted return was about 5.58% a year against 5.43% for his benchmark, an edge of about 0.15 points. His money-weighted return of about 5.16% trailed what the same deposits would have earned in the benchmark, about 5.35%. Over ten years his volatility was 11.3% against 10.0% for his benchmark, and his Sharpe ratio was 0.37 against 0.41. He took more risk and wasn't paid for it.
That record covers the whole portfolio, not the satellite alone, so it can't prove the stocks added nothing. But it gives no evidence that they added much, and it's measured before counting his hours. A record like that argues for a satellite no larger than the rules from module 11 already allow.
His single-stock targets were 5% for the bank and S-REIT and 4% each for the two volatile chip stocks, which adds up to 18%. So Marcus set his satellite at 18% and his core at 82%. Within the core, his world ETF rises to 52%, with the STI ETF at 10%, the bond fund at 15% and T-bills at 5%, so shares still make up 80% of the whole portfolio.
The satellite's size should move with evidence, in both directions, and the rule for moving it should be written now. Otherwise you'll grow it after a lucky year and defend it after an unlucky one.
Marcus wrote: "The satellite is capped at 18% of the portfolio. At each yearly review I compare my three-year time-weighted return, after all money costs, with my benchmark. If I trail it, the cap falls by 5 points. If I beat it by more than the yearly value of my investing hours, as a share of the portfolio, the cap may rise by 5 points, never above 25%."
The second condition is deliberately hard to meet. Lesson 12.5 shows why: once hours are counted, a satellite has to beat its benchmark by a wide margin to pay for itself.
Before you write your own split, gather your returns tab and risk dashboard, and the sizes your module 11 rules allow for each of your stocks.
Write your core and satellite split with the reason, and the measured result that would make you shrink the satellite.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).