Investing in debt instruments is typically meant for conservative investors. However, these include financial instruments with varying levels of risk. For the unversed, risk and returns are directly proportional to each other.
Investors usually run a higher risk by investing in high-risk instruments in a bid to earn higher return. On the contrary, low-risk instruments fetch lower returns.
From time to time, investment experts devise innovative strategies to strike an optimum balance between risk and returns. One such strategy is barbell strategy.
Let us explain what is this strategy and how does it accomplish what it intends to.
What is barbell strategy?
It is an investing strategy that includes investing in high risk as well as low risk financial instruments while overlooking the middle-risk instruments. This strategy aims to strike a balance between the risk and reward.
In this strategy, 90 percent of capital is kept safe, while the remaining 10 percent is invested in extremely risky assets.
Barbell approach entails investing in the two extremes of risk spectrum while leaving out the middle of the range assets. Although this strategy is significant in debt instruments but can be used in equity investment as well.
Both fixed income and equity
The barbell strategy is applicable in both bonds and equity investment. Bonds – in this strategy – can be short-term as well as long term but not of the middle term range. As we all are aware that short-term bonds are relatively safer but offer low returns.
On the other hand, long term bonds given higher returns but are riskier.
So, by investing in financial instruments across risk profiles — one can strike the right balance of risk and reward.
This strategy can be used in equity investment as well by investing in growth stocks and dividend paying stocks. Growth companies are riskier but offer a scope of higher returns. On the other hand, dividend paying firms are more stable but offer limited scope of returns.
When is the strategy effective?
It is effective when investors don’t want to keep their assets locked up in long term bonds. In case interest rates rise, one can raise cash through short term bonds and invest the same in long term.
On the other hand, in case rates fall, one does not need to worry much for already having investment locked in at higher rates. The strategy, therefore, turns out to be effective when there is a sizeable spread in bond yields.
It is vital to note that this strategy is designed with fixed income instruments in mind, and it is effective in case of bond investment.
In conclusion, we can say that returns earned on bonds can be optimised by adhering to a tried-and-tested barbell strategy.
However, it is designed for those who are pros in investing since it calls for investors to keep track of interest rate changes in the real time basis.