Barbell Investment Strategy: Explained

By: Rupesh Oli

What is a Barbell Investment Strategy?

When an investor considers investing in short and long-duration bonds discarding the intermediate-duration bonds, it is known as barbell investment strategy. On the contrary, a strategy which involves investing in intermediate-duration bonds is known as the bullet strategy. This investment strategy creates a barbell shape through the distribution on two extreme ends of the maturity timeline.

Short-duration bonds possess a maturity period of fewer than five years and are considered relatively safer as they have less exposure to interest rate risk. The longer you hold a particular bond, the interest rate risk increases, due to the volatility in the nature of the market. On the other hand, long-duration bonds have a maturity period of 10 years or longer. Although the long-duration bond denotes higher interest rate risk, it offers higher yields as well.

Hence, it can be seen that short-term bonds and long-term bonds are negatively correlated as they depict the exact opposite nature of one another. When one does better, the other falls short and vice-versa. It is due to this, you as an investor will have less downside risk when you acquire the bond of different maturities which is what exactly the barbell investment strategy portrays.

If we take a look at barbell strategy from the perspective of risk-to-reward ratio, it suggests that investors need to invest in two extremes – the high-risk and no-risk assets avoiding the ones which fall on the middle choice. The level of return an investor can expect ultimately boils down to his/her risk-taking attitude and the degree of risk s/he can tolerate. However, in accordance with the barbell strategy, the optimal way to seek the best return on investment is to go for the extremes.

Advocated by Nassim Taleb, a world-renowned statistician, trader, and author, the barbell investment strategy is a widely used approach by the majority of investors/traders globally.

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How does Barbell Investment Strategy Work?

When one thinks of adopting the barbell investment strategy, s/he must consider the degree of risk to be tolerated. For instance, a young professional might possess high risk-taking aptitude, but not the one who is a retiree. Once done, you can then divide the capital amount you possess, into different categories based on the risk level each of the categories represents. The ones with high safety and less prone to risk are bonds and bank certificates of deposit. Then comes the blue-chip stocks, less risky one, however, suffer the ups and downs of the stock market leading to price fluctuation. Further, investment in speculative stocks such as IPOs and startup companies that lack foreseeable performance in the coming years can be considered as the one with higher risk. Cryptocurrency too can be considered on the high-risk segment due to its high volatility in nature.

Once you determine the investment segment based on the level of risk they possess, it’s time you invest. The retiree might consider investing the majority of capital, suppose 70% or 80% on bonds or CDs (bank certificate of deposit) as they possess minimal risk in the above-mentioned category and remaining 30% or 20% in blue-chip stocks. On the other hand, the one with a high-risk appetite might consider investing the majority of their portion with higher risk as they possess higher reward too. Suppose 40% in speculative stocks, 40% in blue-chip stocks, and the remaining 20% in bonds or CDs.

Another approach towards barbell strategy is a 90/10 split making sure 90% of your capital is on the safer side and the remaining 10% on the riskier side creating a mix of both extremely- conservative and aggressive investments. Once again, let’s connect it to the investment in bonds. Long-term bonds are riskier as they are more susceptible to inflation whereas short-term bonds are considered less risky. Hence, when adopting the barbell investment strategy, you can split 10% of your investment on long-term bonds and 90% on short-term bonds.

This is how the barbell investment strategy works as it divides the capital amount into various segments based on the risk-reward ratio.

To demonstrate a few of the instances where the investors have or could have profited from barbell investment strategy, Nassim Taleb bagged profit during the 2008 financial crisis where the majority of investors were facing losses. Funds operated by Talib gained as much as 115% during the financial crisis. It showcases that the barbell investment strategy not only results in profit during the rising market but creates a whopping profit during the downtrend market as well. Moreover, if you would have bought the 10 worst-performing stocks and the 10 best ones in between 1991 and 2005, you would have amassed double the return if compared to the S & P 500 index fund. In this instance, no average or middle stocks are bought, stocks on two extremes were bought denoting the barbell approach.


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Why Should an Investor Consider a Barbell Strategy In Investment?

  • You can invest in high-yield bonds also known as long-term bonds. As you combine the short-term bonds with long-term bonds, the higher risk that you would have accumulated when only acquiring the long-term bonds would be reduced.
  • Barbell strategies not only work in bonds but also in equities as well making it one of the customizable investment strategies where you could leverage by investing in both bonds and equities.
  • It reduces the risk of investing as short-term bonds and long-term bonds are negatively correlated. When long-term bonds are going well in the market, short-term bonds struggle and vice-versa. Hence, it automatically mitigates the risk as you have both variations of bond in your portfolio.
  • When it comes to stock selection, it is better to have diversification of stocks in your portfolio with both value and growth stocks. As the ones who adopt the barbell approach of investing, they comprise their portfolio with both high-risk and low-risk stocks. The value stocks represent low-risk stocks whereas the growth stocks signify high-risk stocks. When considering a barbell strategy for your investment, you are automatically adopting a diversification strategy which is beneficial for you as an investor.
  • If the interest rates rise in the contemporary context, you will have less interest risk. It is because you have short-term bonds in your portfolio. Therefore, you can allow the existing short-term bond to mature and use those proceeds to again buy the bond with higher yields than the previous one. As a result, you will be reinvesting in short-term bonds with higher rates.
  • Short-term bonds provide the opportunity for liquidity in case of emergencies as they mature frequently, moreover, it is highly flexible to deal with.
  • Not only do you acquire short-term bonds, but you will also have the opportunity to amass higher yields through long-term bonds in your portfolio.
  • It provides the investor with greater diversification opportunities if compared to bullet strategy where the investors purchase multiple bonds with the same maturity period.
  • The potential to leverage higher yields is greater than the bullet approach of investing.

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Barbell Investment Strategy: Drawbacks

  • Investors miss out on the opportunity to benefit from intermediate-term bonds as they possess the strong principle that the returns they accumulate with no inclusion of the intermediate-term bonds years will be higher in coming years.
  • Intermediate-term bonds tend to outperform other bond maturities delivering higher interest rates to investors during certain economic cycles; hence investors miss out on this aspect as well.
  • Investors might have to bear the inflation risk if the inflation rate surpasses the interest rate provided by the bonds.
  • When market rates fall below the interest rate provided by the bonds already matured, investors might also face the reinvestment risk as they would not be able to find out the worthwhile investment option afterward.

Barbell Strategy: Stock Investors Vs. Bond Investors

Those who adopt a barbell investment strategy ignore the middle of the risk spectrum. As this strategy includes the pairing of two different types of assets, it is inclusive of investment that falls under the highly safe side on one hand and the ones with higher yield and speculative investments on the other hand. As a stock investor, you can gauge whether the stock that you are going to invest in, fall under the value or growth stocks measuring based on different financial metrics. Once done, you can include both the value and growth stocks in your portfolio. In practicality, barbell strategy is prevalent on bond investors rather than stock investors. The portfolio of bond investors comprises short-term and long-term bonds as elaborated on various instances above. Nevertheless, as an investor, you can act as both the stock investor and bond investor including both the stocks and the bonds in your portfolio.

At The End

As an investor or a trader, you need to be aware of every possible investment strategy. Barbell investment strategy falls among one of those many strategies. You need to figure out whether a barbell investment strategy suits you or not. If not, there exist various other investment strategies that you can adopt. Barbell investment strategy is quite labor-intensive as it seeks frequent attention from the investors. Before delving down into any sort of investment strategy, you, as an investor need to be aware of its pros and cons and the various facets of that particular strategy. In-depth knowledge of how the strategy works and how it can turn out to be valuable for you helps you decide whether to go for that particular strategy or not, no matter if it be the barbell strategy or other investment strategies adopted by the majority of the investors in the market.

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