The Barbell Investment Strategy

Most people use a middle-of-the-road strategy. They want a narrow range of outcomes, because not losing is important. Reducing the possibility of losing money also reduces the possibility of making money. A strategy that provides similar certainty with a possibility of better returns is called a barbell strategy. It is also sometimes called core and explore. Using this strategy, the majority of the capital is invested in dependable assets, while the remainder is invested in high conviction investments with a greater potential return.

As an aside, I have been trying to conceive this approach in the context of robustness that I have been exploring through the last few articles.  This is in part due to the fact that a number of thinkers who also present ideas related to robustness have suggested this particular approach. It is not novel, but it is not commonly practiced. Upon further reflection, it seems to me that this approach is most suited to use with asymetric payoff expectations. It cannot, by itself, improve the robustness of a portfolio.

A barbell strategy combines high dependability with high payoff. I’ll explore how the barbell strategy might be applied to asset classes, then how it might apply to an investment portfolio. I’ve noticed a trend over the last few years of continually declaring new asset classes. I’m sticking with the traditional cash, bonds and stocks, since real estate doesn’t trade in a liquid market and other asset classes, even hedge funds (a strategy, not a class), are really a subset of the three I mentioned.

With bonds, a barbell would hold short-term government bonds on one side, with high yield, longer dated corporate bonds on the other side. The government bonds provide certainty, while the junk bonds provide the return. With equities, one side of the barbell might hold the bluest of blue chips, while the other side holds small cap growth stocks. Another approach might hold cash or equivalents on one hand with high payoff equity options on the other. This is where we can see the role of the asymetric payoffs most easily. While the cash provides guaranteed value, the portion dedicated to equity options has the potential to either lose value (to 0) or to gain value (double or more). This is where all the potential loss or return comes from, but the loss cannot exceed a certain percentage (that allocated to options), whereas the gain is not similarly restricted.

Both sides of the barbell need not be equally weighted. It might make sense to more heavily weight the low risk side of the barbell, taking advantage of the more granular control of risks afforded by this structure. Using a barbell strategy will probably not change the probable return much, but it has additional benefits. It allows an investor to spend time in finding and managing the growth assets, leaving the more dependable assets mostly alone. The is also the possibility of reducing the cost of investments. In a case where an investor were relying on professionally managed money, they could allocate the more passive side to lower cost investments (such as ETFs) while the more active side is allocated to costlier strategies (such as hedge funds).

A final idea that is related to the barbell strategy is to account for other forms of return in your personal financial picture. For example, an entrepreneur may consider their startup business to be the small-cap growth stock side of an equity barbell, and invest their remaining assets in more dependable blue chip companies. A tenured professor may account for their salary income as part of the safe bond portion of their investment strategy. Similarly, a landlord already has exposure to real estate.

In the end, the investment portfolio is likely to produce similar return and variability to a middle-of-the-road strategy. However, the barbell strategy allows an investor to take advantage of higher risk opportunities, especially with asymmetrical expectations. It can further save time and cost by depending on higher dependability investments for the majority of a portfolio, concentrating a portion in high conviction, well understood investments with a greater expectation of return.