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Barbell

A fixed-income portfolio based on a big number of short-term holdings and long-term maturities having no intermediate holdings looks like a barbell. Its instruments are short- and long-term investments and assets divided in two parts. This kind of investment method allows to mix stocks and bonds and is called Barbell strategy or just Barbell.

Understanding of Barbell

The barbell illustrates the idea of combining two extremes and avoiding the middle. The barbell isn't always symmetrical, it just consists of two extremes with nothing in between. Investments with average returns are not worth considering, because nobody guarantees saving money, and the returns are not high enough to take risks.

Short-term investments allow to reinvest more often, they are more flexible and give small, but stable profit. Long-term investment is a small part of capital with a huge risk of loss, but the possibility of increasing the capital by hundreds of times.

Underlying, the main part of the capital will give a stable, low-risk income at the inflation level or slightly above, and the risky part will allow to get additional profitability. At the same time, we are prepared for unexpected negative events, which can happen at any moment, allowing us to buy cheaper assets at the expense of the low-risk part of the capital.

Instead of "average risk" you have high risk on one side and no risk on the other. In total, you have the same "average risk" plus a chance to hit the jackpot.

This strategy is beneficial with rising interest rates. They get a higher interest rate as they roll over short-term maturities, increasing the value.

Risks of Barbell

The main risk of the barbell strategy is the longer barbell end. Long-term securities tend to be much changeable than short-term securities, so there is a risk to lose capital when rates increase. Prices of securities fall when rates increase and the investor decides to sell the securities before they mature. If the investor has an opportunity to hold the bonds until maturity, the resulting fluctuations will have no negative influence.

Yield curve is the worst case for the barbell. This means that short-term securities yields rise much slower than long-term securities yields (and prices fall). In this case, the long end of the barbell falls in price, but there is still a need for the investor to reinvest the short end income in low-yielding securities.

The yield curve with amplification has a counterpart. It is the smoothing yield curve. Short-term securities yields there are rising faster than long-term securities yields. This is much more advantageous for the barbell strategy.

Pros and cons of Barbell

From the one hand, the barbell strategy is about covering bonds and other securities with short- or long-term maturities. Although it is always a good idea to include investments with different maturities in the portfolio, this method concentrates those repayment periods at opposite ends of the spectrum. It is a bread buttered on both sides. The portfolio includes two blocks or groups, not securities, which maturities come sequentially from one period to the other.

From the other hand is inflation, which is the main risk for bonds. It is charged for the rate change in the price growth rate of a commodity bundle and services during a given period. It is possible to find bonds with a variable rate, but the overwhelming majority of stocks have a fixed rate, which may not keep up with inflation.

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Involves long-term securities, which typically provide higher profitability than short-term securities.

Long-term securities occupy money and limit cash flow

Minimizes the risk of interest rate change by reinvesting short-term securities in a rising interest rate conditions.

Risk of interest rate can occur if the long-term securities provide lower profitability than the market one.

Proposes to diversify short-term and long-term maturities when needed.

If prices grow faster than portfolio profitability, there is inflation risk.

Is able to mix stocks and bonds as necessary

Mixing stocks and bonds can increase market risk and instability

As a result, an investment portfolio with barbell strategy demands attention, continuous monitoring and active management.

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