Barbell strategy

#14

What?

• Formed when a trader invests in long- and short-duration bonds, but not in intermediate-duration bonds
• Focuses on the maturities of the securities in the portfolio by ensuring the maturity dates are either very close or at a distant date

Philosophy

• The best way to strike balance between risk and reward by investing in both extremes of high risk vs no risk assets while avoiding middle-of-the-road choices
• Be as hyper-conservative and hyper-aggressive as you can be instead of being mildly aggressive or conservative

When?

• Useful when interest rates are rising
• More frequently applied to bond portfolios

How?

• When short term maturities are rolled over they receive a higher interest rate, raising the value
• If an investor's money is tied up in a long-term high-quality bond, he or she won't be able to put that money in a higher-yielding bond if one becomes available in the meantime

Benefits

• Allows for a quick turnover of a significant amount of the assets in the portfolio at one time
• Reduces interest rate risk since short-term bonds can be reinvested
• Includes long-term bonds, which usually deliver higher yields than short-term bonds
• Offers diversification between short-term and long-term maturities
• Can be customized to hold a mix of equities and bonds

Limitations

• Long-term bonds held till maturity tie up funds and limit cash flow
• Inflation risk exists if prices are rising at a faster pace than the yield of the portfolio
• Mixing equities and bonds can increase market risk and volatility

Etymology

Investment strategy looks like a barbell with bonds heavily weighted at both ends of the maturity timeline

Example

Portfolio created with: 

• Speculative stocks (high risk): initial public offerings (IPOs)
• Blue-chip stocks (less risky): unprotected against ups and downs of the economy
• Bonds (safer)
• Bank certificates of deposit aka CDs (safest)

Asset allocation based on types of investors:

• Risk-loving:
• 40% in speculative stocks
• 40% in blue-chip stocks
• 20% in bonds
• Risk-averse:
• 80% in bonds
• 20% in blue-chip stocks

Related

• Contrast: bullet strategy
• Involves investing only in intermediate-term bonds
• This approach allowed Nassim Taleb, an essayist and mathematician to thrive during the 2008 economic recession while his fellow Wall Streeters floundered