The barbell strategy is an investing strategy that aims to find a balance between risk and reward by investing in high-risk and low-risk assets while eschewing more middle-risk options.
The barbell investing strategy is commonly used for fixed-income investing, but can also be used in equity markets. The goal is to lower an investor’s overall risk profile while still giving exposure to higher-risk, higher-yielding assets.
The barbell strategy works by pairing high-risk, high-return investments with lower-risk, lower-return investments in an attempt to reduce risk without diminishing overall return.
In fixed-income investing, a barbell strategy can be employed by purchasing short- and long-term bonds, but no intermediate-term bonds. Short-term bonds are safer than long-term bonds but also tend to have lower yields. So, by pairing low-risk, low-yield bonds with higher-risk and higher-yielding long-term bonds, investors can theoretically mitigate their portfolio risk without losing too much return.
In equity markets, investors can create a similar barbell by pairing pure growth investments with more income-oriented stocks such as dividend-paying companies. The relative stability of dividend-paying stocks can balance the higher volatility of pure growth stocks, which are often more volatile than the overall market.
It takes a lot of diligence to successfully employ the barbell investing strategy, as bond investors must be constantly reinvesting maturing bonds. Instead, some prefer to use the bullet investing strategy wherein you buy bonds with the same maturity date at different times. The idea is that by purchasing bonds with the same maturity date over time, you can insulate yourself from interest-rate risk.
For example, you might buy a bond today set to mature in 20 years. Then, 5 years from today, you buy another bond that will mature in 15 years. Five years after that, you buy a 10-year bond, and so on. When the bonds all mature at the same time, you begin the strategy again.
The barbell portfolio strategy can be effective for bond investors who don’t want to risk having too much of their capital tied up in long-term bonds in case rates rise. By keeping a portion of the portfolio in short-term bonds, you can keep more cash accessible for investing in new bonds. If rates fall, you’ll still have locked in the higher rates in your long-term bonds. This makes the barbell strategy most effective when there is a large spread in bond yields.
The barbell strategy can also be useful for stock investors who want to target the two extremes of the risk spectrum. Fund managers sometimes use the strategy, so even if you don’t employ it yourself, the mutual funds or exchange-traded funds you invest in may.
- Risk management. By balancing high-risk investments with lower-risk ones, you can reduce risk in your portfolio.
- Higher returns. You don’t have to forgo higher-yielding investments to keep portfolio risk down.
- Labor intensive. For the barbell strategy to work, you need to be constantly monitoring your portfolio – especially when used with bonds – to keep abreast of interest rate changes.
- Bond-focused. While the barbell strategy can be used in equities, it is designed to be used for fixed income.
- No intermediate-term exposure. Intermediate-term bonds can offer better returns than short-term bonds for a minimal increase in risk.