What Is Barbell

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 10 minute read

Do you want to start trading stocks? That feeling is shared by others, too. CNBC reports that new investors under the age of 35 are flooding the stock market. You’ll discover, as you gain experience trading on Wall Street, that your odds of success improve dramatically when you adopt and stick to a certain plan or set of techniques.

Numerous options exist, each with its own set of advantages and disadvantages. The barbell approach is one tactic that is gaining in popularity.

What Exactly Is a Barbell Investing Strategy?

Nassim Nicholas Taleb, author and statistician, describes a method of asset allocation and diversification called the “barbell strategy,” which involves investing in the most high- and lowest-risk asset classes.

The method recommends allocating a portion of your portfolio to high- and low-risk assets, respectively, rather than spreading your money out across a wide variety of stocks and bonds or focusing on a strategy that strikes a happy medium.

Low-risk, low-volatility assets should be held on one side of the barbell. High-risk investments with substantial potential rewards should be located at the other end of the barbell. Keep in mind, though, that the barbell isn’t always stacked in the same way. Your level of comfort with risk will determine how evenly your money is split between the two ends of the barbell.

The theory behind this strategy is that optimally balancing risk and reward will lead to increased profits. More importantly, the barbell approach is not limited to stocks and bonds; it can be used to a wide variety of investments.

The Stock Market’s Barbell Strategy

If you’re using the barbell strategy to invest, stay away from stocks that are in the center of the risk spectrum. Your money will be better spent on a variety of:

  • Blue-chip stocks are known for their consistency and safety. Investors who follow this approach will put the bulk of their money into safe, dividend-paying blue-chip companies like Microsoft (MSFT) and Walmart (WMT), forming the low-risk end of the barbell (WMT).
  • High-Risk, High-Leverage Stocks. To balance out their portfolios, investors who adopt this approach will also put money into more volatile assets that are seen as speculative investments. However, the profits on these riskier investments may be enormous. Startup companies, penny stocks, biotech firms at the trial stage, and derivative investments like binary options are common examples of such assets.

The technique relies on a straightforward principle. Blue-chip companies are known for their consistency and steady dividend payments, both of which you may increase by investing in them.

This safety and income can help you weather the storm of heavy losses in one or two of your riskier investments, while also allowing you to reap the benefits of the substantial returns that such assets can provide when they’re performing well.

It is important to remember that the asset allocation % you choose for each arm of your barbell portfolio is entirely up to you and will primarily depend on your own risk tolerance. 

Investors who aren’t willing to take much of a chance should focus their holdings on safe, stable companies and only invest 10% in more risky ventures. Those who are willing to take on more danger should allocate more of their funds (30%) to speculative bets and the remaining 70% to safe, large-cap equities.

The Barbell Strategy for Bonds

Even while this method may be utilized for stocks, it has found more widespread adoption among those whose portfolios are focused on fixed-income investments like government and corporate bonds as well as municipal bonds. Bonds are viewed as a safer investment option, but they aren’t risk-free.

Opportunity cost is the biggest concern when investing in bonds. When investing in a bond, your funds are essentially “immobilized,” or unavailable for use until the bond matures. This means you can’t sell your current bonds and switch to a newer, higher-yielding bond if a better opportunity presents itself.

Generally speaking, shorter-term bonds pay less interest than longer-term bonds but are easier to sell quickly. Bonds with a longer maturity are often high-yield bonds because of their reputation for paying above-market interest rates; nevertheless, you run the danger of seeing your capital eroded due to the increased time your money is locked up.

Using the barbell approach to bond investing means prioritizing bonds with shorter and longer maturities while ignoring bonds with a medium-term maturity.

Once again, the barbell should be set at a level of difficulty that is appropriate for your own level of risk tolerance. If you’re an investor who doesn’t mind taking on a bit of extra risk, you may allocate 60% of your bond portfolio to short-duration bonds and 40% to long-duration bonds. Those with a low risk tolerance may feel more secure allocating 10% of their portfolio to long-term high-yield bond investments and 90% to shorter-term bonds.

Pros and Cons of Barbell Investing

There are benefits and drawbacks to using a barbell approach to investing, just as there are to using any other investment method. The following are some of the main benefits and drawbacks to think about:

Pros of Stock Market

Those that employ the method find it rewarding for the following reasons:

  1. The result is a more stable situation. One of the most crucial steps in investing is striking a balance between the risks and the rewards. The barbell method is an answer to this predicament since it allows you to take advantage of the possibly greater returns of risky investments while still providing balance through safer, blue-chip equities.

In other words, it’s easy to understand and implement. Finding companies that meet the parameters of a certain investment strategy—be it value investing, income investing, or growth investing—is essential. While it might be challenging for value investors to locate deeply discounted opportunities and for growth investors to identify the finest firms with a clear growth trend, barbell investors are less constrained by these factors. It’s possible to pursue a far wider range of options because of this adaptability.

  1. It Provides Access to Game-Changing Possibilities. This method urges “Go for it!” when most would have told you to stay away from investing in and Alphabet (Google) while they were still in their infancy. A tiny investment in each of these firms when they were young would have yielded a huge return now.

Cons of Stock Market

While there are many upsides to this approach, it is not without its drawbacks. Using the barbell approach to investing might be risky due to the following thorns:

  1. Significant Danger Inherent; Must Take It. No of your strategy, investing always carries some degree of danger. The riskiest equities are bought first, while the safest ones are bought second in this specific investment method. If this happens, the profits made by investing in numerous blue-chip stocks moving more slowly might be lost.
  2. Needs More of Your Time. Because you’ll be putting your money into risky equities, your portfolio will need more attention than that of a buy-and-hold investor, whether you’re aiming for growth, value, or income. In addition to doing monthly rebalancing, you should conduct daily searches or sign up for notifications via news websites to be abreast of developments pertaining to the more speculative firms in which you have invested.

Pros of Barbell Investing in Bonds

The following benefits accrue to bond investors who engage in this strategy:

  1. Bonds with a higher yield are available. Due to the considerable risk involved, many investors avoid bonds with lengthy maturity dates or low credit ratings. Unfortunately, this decision also means they forego the possibility of large gains. When it comes to investing, the barbell technique is useful since it allows for a more balanced exposure to both safer and riskier options.
  2. Lower Danger. This tactic, when used appropriately, substantially lowers danger. The higher stated rates on long-term fixed-income investments sometimes entice novice investors, but they should also consider the opportunity-cost risk. Diversifying your portfolio with low-risk alternatives in the short-term bond market will help you significantly lower your total risk.

Cons of Barbell Investing in Bonds

The barbell approach in bonds has many potential benefits, but there are also some downsides to think about.

  1. Aversion to Forming Intermediate Bonds. The barbell approach recommends investors purchase both long- and short-term bonds while bypassing the intermediate-term bond market entirely. The rates on intermediate-term bonds are much greater than those on assets with a shorter tenure, but the risk is only somewhat higher.
  2. Correct timing is crucial. When interest rates are low, this technique presents a substantial risk for investors. After all, the value of long-term bonds paying today’s low interest rates with a future maturity date will swiftly decline if interest rates increase.

When Is the Best Time to Implement the Barbell Strategy?

That “time is money” is a cliche for a reason. Truer words have never been spoken than when applied to the financial markets. If you don’t time your investments correctly, you might end up losing money.

You’ll soon find out that most investment methods have their optimal moments to utilize, as you gain experience on Wall Street. When is it advisable to employ the barbell tactic, then?

When Should You Use the Barbell Strategy in Stocks?

This tactic may be used at any moment when investing in equities. The end goal of the approach is to minimize exposure to risk while maximizing profit from market extremes. You should diversify your investments and spread out your risk regardless of whether you are investing in a bull or down market.

Furthermore, the approach may be utilized in conjunction with others while investing in equities. The idea behind investing in a bull market is to capitalize on rising prices. 

Combining the barbell with growth tactics will allow you to get the benefits of growth while maintaining the stability afforded by the barbell.

When Should You Use the Bond Barbell Strategy?

If you want to use this approach to bonds, you need to study the yield curve, which shows the difference in rates for bonds of the same credit rating but different maturities over time. 

An upward yield curve indicates that bonds with longer maturities pay more interest than those with shorter maturities. To the contrary, a negative yield curve, also known as an inverted yield curve, indicates that rates at shorter maturities are greater than those at longer ones.

To maximize returns, a barbell portfolio should be invested in while the yield curve is in an upward but flattening trend, meaning that yields on bonds with shorter maturities are increasing at a quicker rate than those with longer maturities. Profitability is boosted by shifting funds into short-term bonds during these periods.

Suggestions for Your Barbell Portfolio

Creating a well-balanced barbell portfolio is an excellent strategy for mitigating risk while accumulating wealth. Choosing a few assets from either end of the risk spectrum isn’t the whole story when it comes to constructing a portfolio using this technique.

Since investing without research is much like gambling, it’s important to do your homework before putting money down. If you want to improve your portfolio, consider these suggestions.

Stock Portfolio Suggestions

In order to successfully construct a barbell portfolio of stocks using this method, you need remember the following:

  • The importance of a diversified portfolio cannot be overstated. If you invest in several different things, you reduce your risk of suffering a major financial setback if any single investment tanked. When employing the barbell method, investors place money in some of the market’s most risky wagers, increasing the likelihood that they would sustain some losses. Accordingly, it is more crucial than ever to have a diverse portfolio.
  • Seek out information. Professional investors will tell you that good research is the backbone of every sound financial choice. Even though you’ll be putting your money into well-respected blue-chip corporations, not all of these titans of industry are made equal. Moreover, you don’t want to take any unnecessary risks with the portfolio’s riskier components. If you do your homework, you’ll know if the high-risk firms you’re considering investing in have a shot at being successful and delivering the kind of substantial returns you’re anticipating. You should basically pay attention to the best of the best and the best of the worst.
  • Every month you should do a rebalance. No matter what your investing plan is, rebalancing your portfolio at least once every three months is a good idea. You should rebalance your portfolio at least once a month if you employ the barbell method, which involves investing in risky equities. If something goes wrong with your speculation stock investments, you need to act swiftly to get out.

Bond Portfolio Tips

These guidelines will help you construct a bond “barbell” portfolio:

  • Mix up your bond portfolio. The market offers a wide variety of bonds with varying maturities. Examples of bonds include those issued by corporations and those issued by municipalities. Bond portfolios benefit from diversification since it spreads out credit risk and increases profits potential.
  • Spreads on Bonds. Spreads on bonds are the equivalent of fees paid on purchases and sales of bonds. This means that finding competitive spreads is essential for keeping costs down.
  • Don’t Invest in Bonds Issued in Other Countries. Investors are drawn to bonds issued by overseas issuers because of the higher returns they often offer. However, if you stick to buying bonds issued within the United States, you won’t have to worry about the hazards associated with investing in bonds issued in other countries. If you’re just starting off, it’s better to avoid buying foreign bonds. Investors with some expertise may want to think about purchasing foreign bonds, but they should first conduct thorough study on these investment instruments to fully grasp the risk involved.

Bottom Line

The barbell method is a relatively new investment approach, with the first widespread references appearing during the Great Recession of 2007–08. Nonetheless, the successes of the time period have contributed to its rising appeal.

The purpose of the barbell strategy, like with other investment approaches, is to maximize returns while limiting losses.

No matter what approach you use to investing, remember that solid research is the bedrock of a successful financial choice. The allocation of your investment funds is something you should keep track of at all times, but especially if you’re employing a strategy that calls for the purchase of high-risk assets.

Curated posts

Someone from New York, NY just viewed Best Online Colleges for Business Degrees