Investing with a barbell strategy offers you a way to gain exposure to a particular bond maturity length. In addition, in your investment, it won’t be in the same segment of the market.
For instance, an investor who wants exposure to the ten-year maturity segment could invest all of his cash in ten-year bonds. In other words, it is a “bullet strategy”.
However, to diversify risk, the investor could invest half of their portfolio in bonds with five-year maturities. The other half in bonds with 15-year maturities to achieve an average maturity of ten years.
A bond barbell doesn’t necessarily need to have equal weight on both sides—it can be heavier on one end based on an investor’s outlook and yield requirements.
According to thebalance.com, here is the explanation of the barbell structure and its benefits.
The Barbell Structure
The barbell strategy generally divides a portfolio into two sections, a low-risk side, and a high-risk side. Short-term bonds fill with the conservative side of the portfolio. While, the higher risk side of the portfolio is full of long-term, higher risk bonds.
Long-term bonds carry more risk because they are more susceptible to rising inflation.
Meanwhile, short term bonds, which mature in five years or less, are less likely to be affected by inflation and are therefore considered less risky in a barbell strategy.
To build a barbell bond portfolio, an investor could split their investments into a 90/10 split, where 90% of their investments are short-term, and 10% are long-term. The short-term side of the barbell would then be referred to as being heavier because it has more investments.
Benefits of the Barbell
The potential benefits of investing using a barbell strategy are:
- Greater diversification than a bullet strategy—purchasing multiple bonds that mature at the same time
- The potential to achieve higher yields than would be possible through a bulleted approach
- Less risk that falling rates will force the investor to reinvest their funds at lower rates when their bonds mature
- If rates rise, the investor will have the opportunity to reinvest the proceeds of the shorter-term securities at the higher rate
- Short-term bonds mature frequently, providing the investor with the liquidity and flexibility to deal with emergencies