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  • Nick Burgess

Should You Use The Barbell Investment Strategy?

The following article is for entertainment and educational purposes only, and should not be considered financial advice. Please contact a licensed financial advisor for individualized advice. Some links below may be affiliate links that generate a small commission for the site at no added cost to you.

 

Should You Use The Barbell Investment Strategy?

Whether you're an individual investor navigating the financial world or a financial advisor seeking the best investment advice, understanding the landscape of investment strategies is essential. This was one investment strategy that was completely off my radar until I ran into a Vanity Fair video from 2018 that features everyone's favorite unhinged NBA owner: Mark Cuban. Cuban describes his strategies for getting rich, and casually mentions the barbell method:

The barbell strategy is one approach you may have heard about but aren't quite sure how it works. In its simplest sense, the barbell strategy is a method of asset allocation, which, like a barbell, puts weight on two extreme ends while the middle remains light. Let's delve deeper.

a weightlifter loading a barbell on the floor

The Barbell Approach

The barbell approach to investing is a method of managing a portfolio that involves putting money in high-risk investments on one side of the barbell, such as equities, cryptocurrency and private equity, and in low-risk, low-yield bonds on the other side, often government bonds or short-term bonds. The goal is to balance the potential for higher returns with the security of lower risk.

In between these two extremes, in the place of intermediate-term bonds, are a minimal number of medium-term bonds. This strategy is in direct contrast to a bullet strategy that involves mainly focusing on medium-duration bonds. The central idea behind barbell strategies is to diversify across asset classes to reduce downside risk and increase the potential for higher yields and outsized returns on one end of the barbell.


Exploring the Barbell Investment Strategy

At this point, it's essential to clarify that past performance is not indicative of future results. But let's take a look at how the barbell investment strategy has fared during good times and bad.


During periods of economic growth and higher rates, the high-risk side of the barbell often generates substantial cash flow and better returns (as expected!).

In a financial crisis, this part of the portfolio may crater, but the lower risk end, containing safer short-term bonds, helps shield investors from the full brunt of the market conditions. Even when facing a financial crisis, investors who adopt a barbell approach can still realize long-term returns.


It's important to note that the lower end of the barbell should not be money you're using to buy a home, or anything you might need in the next 5 years. Despite the "safety" that the lower end of the barbell brings, the only way to truly preserve your cash is looking at high-yield savings accounts.


High Risk, High Yield?

On the higher-risk side of the barbell, you might find high-risk assets such as value stocks, real estate, or even investment products from countries of the European Union, Hong Kong, or Saudi Arabia. While higher risk can often mean a chance of better returns, it's essential to assess each investment's credit risk and potential downside. Professional asset managers or independent financial advisors can provide valuable guidance.


Low Risk, Lower Yields?

The low-risk end of the barbell can include short-term bonds, government bonds, mutual funds, TIPS, really anything that makes you fall asleep at the dinner table. While these investments might generate lower yields compared to high-risk investments, they provide a potential buffer against market volatility and protect your portfolio during rare events or black swan events as famously coined by Nassim Taleb.


Navigating Interest Rate Risk

A barbell portfolio strategy can provide a robust mechanism to navigate interest rate risk. When the yield curve is flat, new bonds offer the same yield, irrespective of the duration. But when central banks change policy leading to a rising rate environment, short durations suffer less compared to longer-term bonds. The barbell strategy, by avoiding longer duration and focusing on short and long-term bonds, may provide better returns.

In the case of a higher interest rate or a rising-rate environment, the shorter-term bonds or low-yield bonds in the portfolio can be rolled over into new bonds at higher rates, boosting the overall yield. On the other hand, in a situation of lower interest rates, the longer-term bonds or 10-year bond in the portfolio help maintain higher yields due to their longer duration and locked-in rates.


Is the Barbell Strategy a Good Idea for You?

Deciding if the barbell strategy is a good idea will depend on your personal circumstances and risk tolerance. For example, the best time to employ the barbell strategy may differ depending on market conditions, your financial goals, and your comfort with higher-risk investments.


It's crucial to keep in mind that while the barbell strategy can provide a buffer against volatility, it doesn't eliminate risk entirely. High-yield bonds, equities, or real estate can still suffer during economic downturns. The lower risk end, while safer, will yield lower returns. Moreover, the barbell strategy requires active management and constant rebalancing to maintain the appropriate asset allocation.

For these reasons, this strategy is commonly used by professional asset managers or savvy individual investors rather than novices. If you're considering this strategy, you should seek advice from a financial adviser, a financial advisor, or an investment advisor to understand the full implications.

Conclusion

Remember that any investment strategy should align with your overall financial goals and risk tolerance. The barbell investing approach is just one of many strategies available to investors. Understanding the concept and weighing the pros and cons can help you decide if it's the right strategy for you. Whether you choose barbell investing, an index fund, or exchange-traded funds, remember that asset allocation is key to a diversified and balanced portfolio.

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