We live in a world marked by a great deal of volatility and uncertainty. Record high corporate profits sit side by side with predictions of an economic downturn upon the end of quantitative easing (fancy spin for printing money until we drop) in June of this year.  Some would argue, most notably Nassim Nicholas Taleb. we under- estimate randomness in our lives and that predictability is most illusionary. In the context of such randomness- financial or otherwise- there has been a growing movement, especially in high-net worth circles, to adopt a barbell investing strategy.

As the name implies, a barbell investing strategy is weighed at both ends with extremes of asset allocation with a thin to non-existent middle. One of the underlying beliefs of a barbell investing strategy, as with any asset allocation strategy, is to even out volatility. Philosophically, some argue, if we live in a world of volatility, we can no longer gauge risk accurately. How do you know if something is a moderate risk where a regime stands one day and falls the next-  do you listen to the risk management experts who look great backtesting but are equally inept predicting the future as you or I?

The barbell strategys underlying philosophy is that the market will do poorly or will do well. But it will probably avoid a cushy sideways movement for long periods of time. To this end, it takes extreme positions. If you are a fixed income investor, a barbell asset allocation involves investing in short-term government issued bonds on one end and long term, high yield corporate bonds on the other end. If the corporate bonds do not pay out, the investor still has the government bonds to rely upon.

If an investor is allocating between cash, fixed income and equities, a barbell investing strategy would recommend a large holding in conservative fixed income positions (short term, highly rated government bonds) and then a small holdings in extremely high risk/high reward equities with some experts recommending purchasing options and/or extremely leveraged positions (think triple-leveraged ETFs as an example). Thus, on the thin wedge of the portfolio, the risk/reward proposition is relatively quite high but with a large buffer to mitigate against the entire portfolio suffering.

It is, admittedly, a strategy not fit for all. It requires real fortitude on the riskier end of the allocation. It is also a strategy that assumes the world/market will be an unpredictable place and the only outcomes are no risk/high risk. However, it does give some real food for thought when high-net worth advisors are pushing this strategy; it may indicate the new normal in the future is, by nature, an unpredictable and rocky place.

3 Comments on What is the barbell investing strategy?

By Balance Junkie on March 8, 2011 at 2:51 pm

I guess there are quite a few different ways to implement a barbell strategy. Im not comfortable using options or leveraged investments, but I like the idea of reducing risk overall while keeping a toe in the water in hopes of increasing returns a little.

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