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Barbell Strategy – What it is and How it Works

barbell strategy

To get the most of this article, you should be familiar with the idea and basic shape of the yield curve.  If not, please read this.

When talking about bonds a barbell strategy is when you divide your portfolio between long-term and short-term bonds, with nothing in the intermediate maturities. It is referred to as a barbell because your investments are stacked at opposite extremes from one another, like the weights on a barbell. Barbells contrast with bullets, where your portfolio is stacked around one maturity date, and ladders where your portfolio is spread evenly over short, intermediate, and long term maturities.

Why people use barbell strategies

Barbell strategies are simply another way to try and deal with interest rate and reinvestment rate risk. The large portion of your portfolio which is invested in short term bonds offers protection when interest rates rise. Your short term bonds will mature quickly and you will be able to reinvest the principal at the new higher rates. The large portion of your portfolio which is invested in long term bonds offers protection from falling interest rates, as this portion of your portfolio will be locked in at the higher rate you got when you initially invested.

 

Rising rates favor the barbell strategy

Generally rising interest rates favor a barbell strategy because you are reinvesting a large portion of your portfolio at regular intervals, locking in higher rates. This of course works against you when interest rates are falling, and you are reinvesting at lower and lower rates. The worst case scenario for a barbell strategy is when the yield curve steepens as short term rates fall and long term rates rise. In this scenario you are losing out both when you reinvest the short term bonds in your portfolio, and as the value of the long term bonds drop as interest rates rise on the long end.

 

How to implement the barbell strategy

The most common and straightforward allocation for the strategy is to divide the fixed income portion of your portfolio equally between short and long term bonds. As for instruments, the easiest way to set up a barbell strategy is by using short term and long term bond ETFs. For the short term portion of your bonds you could use VGSH for short term government bonds and VCSH for your short term corporate bonds. For the long term portion you could use the TLT for your government bond exposure and VCLT for your long term corporate bond exposure.

The advantage to using ETFs is that you do not have to roll your positions over, as the ETFs maintain a constant maturity. Keep in mind however that you will still need to rebalance your portfolio periodically to make sure that your allocations remain consistent.

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David Waring was the founder of LearnBonds.com and has been a major contributor to the extensive library of investing news and information available on the site. Until the launch of Learnbonds.com in late 2011 there was no single site on the internet catering exclusively to the individual bond investor. This was true even though more individuals own stocks than bonds. Learn Bonds was launched to fill that gap.