A portfolio with only short-term and long-term bonds
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What is the Barbell Strategy?
The barbell strategy involves investors purchasing short-term and long-term bonds, but not intermediate-term bonds. The particular distribution on the two extreme ends of the maturity timeline creates a barbell shape. The strategy offers investors exposure to high yielding bonds with limited risk.
Summary
- The barbell strategy is a fixed income strategy where the investor only buys short-term and long-term bonds.
- The strategy helps decrease downside risk while still having exposure to higher-yield, long-term bonds.
- A flattening yield curve environment is best suited for the barbell strategy, while a steepening curve is detrimental to the strategy.
Why Use a Barbell Strategy?
The barbell strategy lowers risks for investors while providing exposure to higher yield bonds. Short-term bonds have a maturity rate of fewer than five years. They are relatively safer than long-term bonds due to less exposure to interest rate risk. The strategy also includes buying long-term bonds, which have maturities of 10 years or longer. The bonds offer higher yields to compensate for higher interest rate risk.
The first advantage of the strategy is that it enables investors to have access to higher yield long-term bonds. The second advantage is that it decreases risk. The strategy lowers risk as short-term and long-term bonds’ returns tend to be negatively correlated. So, when short-term bonds do well, the long-term bonds tend to struggle and vice versa. Thus, by holding bonds with different maturities, investors have less downside risk.
The reason the returns are negatively correlated is because of interest rates. If interest rates increase, the short-term bonds will be rolled over and reinvested at a higher interest rate. The reinvestment will offset the decrease in the value of longer-term bonds. On the other hand, if interest rates decrease, the value of the longer-term bonds will increase.
An Active Form of Portfolio Management
The barbell strategy requires active management. It is because as short-term bonds reach their maturity, new short-term bonds must be purchased to replace them. The same goes for long-term bonds. As maturity dates approach, an investor must buy new long-term bonds. It helps maintain the barbell strategy. Without active management of the strategy, the investor will end up with only long-term bonds that are susceptible to interest rate risk.
What are the Risks?
Interest rate risk is still a concern even though the investor owns both long-term and short-term bonds. If long term bonds are purchased when interest rates are relatively low, they might end up with bonds that quickly lose value as interest rates increase.
Another risk or tradeoff of the barbell strategy is that the investor lacks exposure to intermediate-term bonds. Historically, intermediate-term bonds offer better returns than short-term bonds. Additionally, they are only slightly riskier. Compared to long term bonds, the return is only slightly lower. By excluding intermediate-term bonds, investors might be losing out on additional returns.
When is the Best Time for the Barbell Strategy?
The best time for using the barbell strategy is when the yield curve is flattening. A flat yield curve means that there is little difference between the yield of a short-term bond and a long-term bond. Usually, a normal yield curve slopes up and plateaus. It is because investors need to be compensated with the higher yield for taking on the additional risk of long-term bonds. In a flattening yield curve, the spread between a short-term and long-term bond shrinks.
Another way to think of a flattening yield curve is that yields on short term bonds rise faster than that of long term bonds. On the other hand, a steepening yield curve is the opposite. This is when yields on long-term bonds are increasing faster than on short term bonds. When it occurs, the value of long term bonds decreases faster. In a barbell strategy, investors might need to invest in lower-yield, short-term bonds to balance the portfolio.
In a flat yield curve, investors can reinvest proceeds from maturing short-term bonds into new bonds with a faster-growing yield.
Additional Resources
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FAQs
The barbell strategy is a fixed income strategy where the investor only buys short-term and long-term bonds. The strategy helps decrease downside risk while still having exposure to higher-yield, long-term bonds.
What is an example of a barbell strategy? ›
For example, suppose an investor holds a two-year bond that pays a 1% yield. Market interest rates rise so that current two-year bonds now yield 3%. The investor allows the existing two-year bond to mature and uses those proceeds to buy a new issue, two-year bond paying the 3% yield.
What is the barbell shaped strategy? ›
At its heart, the Barbell Strategy is a risk management approach that involves allocating your resources into two extreme ends of the risk spectrum while avoiding the middle ground. It derives its name from the image of a barbell, with weights concentrated on both ends and nothing in between.
What is the barbell strategy in life? ›
The barbell strategy is an approach to uncertainty (risk) that uses two extremes - like weights on the opposite ends of a barbell - to avoid ruin and simultaneously expose yourself to a speculative upside.
What is barbell strategy in economics? ›
What Is the Barbell Strategy? The barbell strategy is an investment concept that suggests that the best way to strike a balance between reward and risk is to invest in the two extremes of high-risk and no-risk assets while avoiding middle-of-the-road choices.
Does the barbell strategy work? ›
The barbell strategy lowers risks for investors while providing exposure to higher yield bonds. Short-term bonds have a maturity rate of fewer than five years. They are relatively safer than long-term bonds due to less exposure to interest rate risk.
What is the opposite of the barbell strategy? ›
The barbell strategy in fixed income is the opposite of a “bullet” strategy, in which the portfolio is concentrated in bonds of a particular maturity or duration.
How is barbell strategy different from waterfall strategy? ›
Barbell strategy uses a combination of safety nets to which are placed in the most vulnerable sectors of the economy so as to tackle the challenges on a real time basis contrary to the waterfall approach which involves assessment of the economic indicators at the beginning of a period and assumes that this assessment ...
What is barbell menu strategy? ›
Barbell pricing promotes low and high-priced menu items. This strategy is gaining momentum in today's uncertain economic environment. For some restaurants, this may include small plates. For others, this approach entails offering some items with lower-cost ingredients.
What is the barbell strategy for retirement? ›
Solution: Barbell
Like a ladder, a barbell strategy involves purchasing bonds with different maturity dates. However, a barbell focuses exclusively on short- and longer-term bonds—and avoids medium-term bonds entirely.
A barbelled personality is one that is optimistic about the future, but also paranoid about what could go wrong along the way. A person with a barbelled personality is clear about what they want. They've written down their goals and visualized their achievement in detail.
What is the 3 bar strategy? ›
What Is a 3 Bar Play? It's a popular but simple strategy of recognition of reversal based on 3 bars that signify a bullish or bearish trend after a sustaining trend in the opposite direction.
What is the barbell strategy of cash? ›
The barbell method recommends putting your money into a range of assets from very risky to completely safe while disregarding the somewhat risky assets. The barbell technique recommends mixing short-term and longer-term bonds when investing in fixed income.
What are the percentages of the barbell strategy? ›
Variations. One variation of the barbell strategy involves investing 90% of one's assets in extremely safe instruments, such as treasury bills, with the remaining 10% being used to make diversified, speculative bets that have massive payoff potential.
What is the barbell income strategy? ›
The Barbell Strategy
In weightlifting, a barbell has weights on both ends with a long bar in between. The barbell strategy in investing involves holding a mix of short-term and long-term bonds, with little to no intermediate-term bonds. This strategy is designed to capture both stability and high yields.
What is the barbell content strategy? ›
The Barbell Content Strategy reduces that risk and puts you in a position to generate a linear return on your investment in a worst case scenario while setting yourself up for a best case scenario of capturing surprising and unmodeled upside.
What is the barbell strategy of credit? ›
Enter the 'credit barbell'
One approach to optimize yield in this environment is a “credit barbell” strategy, which involves investing opportunistically at both the shorter and longer ends of the yield curve. Such an approach may be attractive for several reasons.
