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Barbell Investing Strategy – Definition & How to Approach for Your Portfolio

Are you planning on getting started in the stock market? You’re not alone. According to CNBC, young investors have been piling into stocks. As you begin to get your feet wet on Wall Street, you’ll quickly find that having and following an investing strategy or a group of strategies will greatly increase your probability of profitability.

There are plenty of strategies to choose from, each with its own pros and cons. One strategy that’s becoming increasingly popular is known as the barbell strategy.

What Is a Barbell Investment Strategy?

As described by author and statistician Nassim Nicholas Taleb, the barbell strategy is an asset allocation and diversification strategy centered around investing in extremes in terms of risk. The strategy suggests that instead of investing in a diversified list of stocks or bonds ranging in levels of risk or focusing your investments on a medium-risk strategy, you should invest some of your investing dollars with the extremes in mind.

On one side of the barbell, you should invest in low-risk, low-volatility assets. On the other end of the barbell should be a group of high-risk assets with big upside potential. However, it’s important to keep in mind that the barbell isn’t always evenly distributed. The distribution of funds to either side of the barbell depends on your risk tolerance.

The belief is that by taking this approach, you’ll be able to better balance risk and reward, resulting in higher returns. Moreover, the barbell investing strategy can be used across a wide range of assets, with the most common being stocks and bonds.

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The Barbell Strategy for Stocks

When taking the barbell approach to investing in stocks, you’ll want to avoid stocks that lie in the middle in terms of risk. Instead, you’ll be focusing your investments on a mix of:

  • Extremely Stable Blue-Chip Stocks. Forming the minimal-risk end of the barbell, investors who follow this strategy will nest the majority of their investing dollars in stable, dividend-paying, blue-chip stocks like Microsoft (MSFT) and Walmart (WMT).
  • Highly Leveraged Speculative Stocks. On the other side of the portfolio, investors who follow this strategy also will invest in riskier assets that are considered speculative bets and which are often known for fast-paced price fluctuations. But, these higher-risk assets also have the potential to generate significantly higher returns. These assets often include startups, penny stocks, clinical-stage biotechnology stocks, and in some cases, derivative investments like binary options.

The concept behind the strategy is simple. By investing in stable, blue-chip stocks, you’ll bring stability and income to your portfolio. This stability and income give you a way to offset any significant losses that may be experienced in one or two of your more speculative assets while giving you the opportunity to enjoy the strong gains these higher-risk assets are sometimes known to generate.

Keep in mind that the percentage of assets you allocate to each side of your barbell portfolio is completely up to you and largely depends on your personal risk tolerance. For an investor with a minimal appetite for risk, a portfolio consisting of 10% speculative assets and 90% blue-chip assets is fitting. Those with a larger appetite for risk may want to invest 30% into speculative bets and 70% into stable large-cap stocks.

The Barbell Strategy for Bonds

While this strategy can be used for stocks, it is most popular among investors with fixed-income portfolios centered around investing in corporate bonds, treasury bonds, and municipal bonds. While these are considered to be lower-risk assets, bonds are far from no-risk assets.

The most significant risk associated with bonds is known as opportunity cost. When money is tied up in a bond, it’s illiquid, meaning it’s difficult to get your money back out until the bond matures. So, if a new bond comes along with a higher return, you won’t be able to exit your position to move toward the new bond.

Bonds with a shorter term are more liquid but are also known to pay lower interest rates than bonds with longer lifespans. Longer-term bonds are generally high-yield bonds because they’re known to pay higher rates, but your money will be tied up in these investments for a longer period of time, leading to expanded opportunity-cost risk.

So, when applying the barbell to your bond investments, you’ll completely ignore bonds with a medium-term maturity and focus your investments on short-term and long-term bonds.

Again, your barbell should be adjusted to your unique risk tolerance. Investors comfortable with relatively more risk may invest 40% of their bond-investing dollars in long-duration bonds and 60% in short-duration bonds. Those with a minimal appetite for risk might be more comfortable with 10% of their portfolio invested in high-yield bond investments that take a while to mature and 90% of their portfolio in short-term bonds.


Barbell Investing Pros and Cons

Barbell investing is becoming an increasingly popular strategy, but as with anything else, it comes with advantages and disadvantages. Some of the most significant pros and cons to consider include:

Pros of Barbell Investing in Stocks

Investors who use the strategy enjoy doing so because:

  1. It Provides Balance. Balancing risk and reward is one of the most important processes associated with investing, but it’s also one of the most difficult for beginners. The barbell strategy solves that problem by giving you access to the potentially higher returns of speculative investments while providing balance through safer, blue-chip stocks.
  2. It’s Simple to Follow. The value investing, income investing, and growth investing strategies all require investors to find stocks that fall into specific categories and fit a set of criteria. Although a value investor may find it difficult to find sufficiently discounted opportunities and growth investors may have a difficult time finding the best stocks with a defined growth trend, barbell investors don’t necessarily have to follow such stringent requirements when picking stocks. This flexibility opens the door to far more potential opportunities.
  3. It Opens the Door to Life-Changing Opportunities. Most investing strategies would have pointed you away from investing in startup companies like Amazon.com and Alphabet (Google) in their infancy, but this strategy says “Go for it!” If you invested even a relatively small amount of money in either of these companies when they were young, you’d be sitting on a massive profit today.

Cons of Barbell Investing in Stocks

Sure, there are quite a few benefits to using this strategy, but every rose has its thorns. Here are the sharpest thorns that can snag you when using the barbell investing strategy:

  1. Significant Risk Must Be Accepted. Investing involves risk, no matter how you go about it. However, this particular strategy is based on investing in stocks with the highest levels of risk and balancing them out with the lowest-risk investments. This can open the door to significant individual stock losses that could wipe out the gains across several slower-moving blue-chip stocks.
  2. Requires a Larger Time Commitment. Because you’ll be investing in highly speculative stocks, your investment portfolio is going to require more maintenance than that of a buy-and-hold growth, value, or income investor. Not only is monthly rebalancing a must, but you’ll also need to pay close attention to news from the more speculative companies you invest in, making daily searches or signing up for alerts through news websites a must.

Pros of Barbell Investing in Bonds

Investors who take part in this strategy for bond investments enjoy the following:

  1. Access to Higher-Yield Bonds. Many investors steer clear of bonds with extended maturity dates or poor credit ratings due to the high risk. However, this also means they give up the potential for high returns. The barbell strategy provides a measure of exposure to investments that offer larger potential gains.
  2. Decreased Risk. When employed at the right time, this strategy greatly reduces risk. Beginner investors are often driven to long-term fixed-income investments by the higher stated yields without thinking about the opportunity-cost risk. By balancing these investments with low-risk opportunities on the short-term bond market, you’ll be greatly reducing your overall risk.

Cons of Barbell Investing in Bonds

There are plenty of reasons to consider using the barbell strategy in bonds, but there are some drawbacks to consider:

  1. Avoidance of Intermediate Bonds. The barbell strategy suggests investors should buy long-term and short-term bonds while completely ignoring intermediate-term bonds. Many consider this to be a mistake, because intermediate-term bonds come with significantly higher yields than investments with a shorter maturity, but only slightly increased risk.
  2. Timing is Everything. Investors who employ this strategy when interest rates are low will be taking on significant risk. After all, as interest rates rise, bonds that pay today’s lower rates with extended maturity will quickly lose value.

The Best Time to Use the Barbell Strategy

Everyone has heard the old adage “time is money.” That statement’s nowhere more true than it is in the financial markets. The timing of your investments will often make the difference between profit and loss. As you get your feet wet on Wall Street, you’ll learn that most investing strategies are best used at specific times.

So, what’s the best time to use the barbell strategy?

When to Use the Barbell Strategy for Stocks

When it comes to stocks, any time is a good time to use this strategy. Ultimately, the strategy is designed to balance risk by taking advantage of extremes in the market. Regardless of whether you’re investing during a bull market or a bear market, you’ll want to practice diversification and balance your risk.

Moreover, when investing in stocks, the strategy can be used alongside others. For example, when investing in a bull market, you’ll want to take advantage of the growth as valuations rise. By mixing the barbell and growth strategies, you’ll have the ability to profit from that growth while taking advantage of the balance the barbell provides.

When to Use the Barbell Strategy for Bonds

When applying this strategy to bonds, it’s important to pay attention to the yield curve, which plots the yields of bonds with the same credit quality but different maturities. When the curve is upward, it means longer-maturity bonds pay higher interest than shorter-maturity bonds. Conversely, when the yield curve is downward — also called an inverted yield curve — it means shorter-maturity yields are higher than longer-maturity yields.

The sweet spot for the barbell strategy is when the yield curve is upward but flattening — when rates on short-term bonds begin to move in line with those on bonds with longer maturities, ultimately meaning shorter-maturity bond yields are rising faster than longer-maturity yields.

During these times, rotating money into short-term bonds will greatly increase your potential profitability.


Tips for Your Barbell Portfolio

Building a solid barbell portfolio is a great way to manage risk as you work to build wealth. However, there’s more to building a portfolio employing this strategy than blindly choosing a few assets on each side of the risk spectrum. After all, investing blindly is akin to gambling.

Here are a few tips to help you build your portfolio:

Stock Portfolio Tips

If you plan on using this strategy to build a barbell portfolio of stocks, keep the following tips in mind:

  • Diversification Is Always Important. Diversification is the process of spreading your investments over a long list of assets to protect yourself from significant losses should one or more of your investments take a dive. The barbell strategy involves investing in some of the most speculative bets on the market, meaning there’s a high probability of generating losses here and there. So, it’s even more important to maintain a highly diversified portfolio.
  • Do Your Research. Expert investors will tell you that the basis for any solid investment decision is quality research. Even though you’ll be investing in highly trusted blue-chip companies, even these established companies aren’t all created equal, and you want to invest in the best of the best. Moreover, when it comes to the risky side of the portfolio, you don’t want to take any undue risks. Your research will tell you if there’s a real possibility that the risky companies you invest in will make it big and yield the significant returns you’re hoping for when you accept the risk. Essentially, you’ll want to focus on both the best of the best and the best of the worst.
  • Monthly Rebalancing Is a Must. It’s wise to rebalance your portfolio on at least a quarterly basis, no matter what investment strategy you’re using. However, because the barbell strategy includes investing in speculative stocks, you should rebalance monthly at least. When investing in speculative stocks, you want to stay on top of those investments and make a quick exit if something goes wrong.

Bond Portfolio Tips

If you’re more interested in building a barbell portfolio of bonds, follow these tips:

  • Diversify Bond Types. There are several different types of bonds on the market, regardless of the amount of time to maturity. For example, corporate bonds are investments in companies while municipal bonds are issued by local governments. When investing in bonds, include a mix of different types of bonds to reduce potential credit risks while expanding potential earnings.
  • Bond Spreads. Bond spreads are essentially commissions you’ll be charged when you buy and sell bonds. As such, you’ll want to look for low spreads to keep your cost down.
  • Steer Clear of Foreign Bonds. Bonds from foreign issuers often attract investors because they are known to offer higher yields. However, investing in foreign bonds will expose your portfolio to risks you won’t have to deal with if you keep your investments domestic. As a beginner, it’s best to stay away from foreign bonds. Investors with a bit of experience may consider foreign bonds but should do detailed research into these investment vehicles to get an understanding of the risk before doing so.

Pro tip: Before you add any stocks to your portfolio, make sure you’re choosing the best possible companies. Stock screeners like Trade Ideas can help you narrow down the choices to companies that meet your individual requirements. Learn more about our favorite stock screeners.


Final Word

With the first popular mentions of the barbell strategy popping up during the 2007 and 2008 economic recession, the strategy is relatively young. Nonetheless, the success stories it produced during this period made it popular, and that popularity is only growing.

As with most investing strategies, those who employ the barbell strategy have the goal of achieving strong gains while minimizing risk.

Regardless of which strategy you choose to use as you invest, it’s important to keep in mind that research is the foundation of any strong investment decision. You should always know where your investing dollars are going, especially if you plan on using a strategy that requires investments in high-risk assets.

Joshua Rodriguez
Joshua Rodriguez has worked in the finance and investing industry for more than a decade. In 2012, he decided he was ready to break free from the 9 to 5 rat race. By 2013, he became his own boss and hasn’t looked back since. Today, Joshua enjoys sharing his experience and expertise with up and comers to help enrich the financial lives of the masses rather than fuel the ongoing economic divide. When he’s not writing, helping up and comers in the freelance industry, and making his own investments and wise financial decisions, Joshua enjoys spending time with his wife, son, daughter, and eight large breed dogs. See what Joshua is up to by following his Twitter or contact him through his website, CNA Finance.

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