The barbell strategy: Using extremely risky and safe investments
How does a barbell look? It is a long metal bar where you can attach weights that you can connect on both ends. It is common gym equipment, and it is used in weightlifting. However, did you know that we also had a strategy called barbell in investments and finance? Today’s lesson will walk you through its meaning and how it ended up being called as such.
Barbell in the world of investments and finance
Many people devised different kinds of strategies in investing, and that includes the barbell strategy. It is a concept saying that there are two choices to balance risk and reward: invest in two extremes of no-risk and high-risk. It says that an investor should avoid the choices that fall in between the extremes. Hence, if you think about the actual barbell, it carries two heavyweights on both sides. Every strategy created is meant to help investors get the best possible return with the most tolerable risk that the said investor can take. The barbell strategy states that the best way to achieve this is through the extremes.
Risks and portfolios
Different people have different preferences and risk tolerances. Hence, people who use strategies delegates their money into three categories when they create their portfolios and they are:
- High risk. These stocks can be the ones that just made their IPO or initial public offering. They can also be speculative stocks or those from small biotechnology companies.
- Average risk. The most common example would be the blue-chip stocks. While they may be less risky, the economy’s situation can still affect them massively.
- Low risk. If an investor wants the safest investment out there, most people would suggest bonds or bank certificates of deposit.
What does age have to do with investing behaviors?
They say that a young person is bolder and braver when it comes to taking a risk. On the other hand, older people like retirees are more conservative regarding investments and risks. Why? These people consider the best return that they can get with the risk that they are comfortable taking. For example, a young person can invest more of his money in speculative and blue-chip stocks and less in bonds and CDs. On the other hand, a retiree will be more conservative and allocate most of his money on bonds, less on blue-chip stocks, and none for the speculative ones.
Explaining the strategy
The barbell strategy tells investors that it is best to ignore the investments that have moderate risks totally. Hence, an investor should get a pair of assets that are considerably distinct from each other. One basket contains extremely risky investments, while the other one holds extremely safe investments.
Barbell strategy and bonds
The barbell strategy is most common in portfolios with bonds. The most significant risk that people who have high-quality bonds is a missed opportunity for a bond that can give better returns. Moreover, the investor loses the opportunity to take a higher-yielding bond that suddenly becomes available if they invested in a longer-term bond.
It is a lot of work
While bonds are considered safe investments, they still demand much work if the barbell strategy is applied. Thus, other people resort to the bullet strategy — the barbell strategy’s antithesis. In a bullet strategy, investors commit. They buy bonds that will all mature after seven years. Until then, they will be idle, so it means less work for investors. Investors become immune from the interest rate movements, and they do not need to reinvest their money all the time.