Invest Using the Barbell Strategy to Maximize Returns While Staying Safe
By: Smart Personal Finance
Tags: Investing, Money, Money Management, Books, Stock Market

The Barbell Strategy of Investing

Nassim Taleb is one of the world’s top experts in investing, having written a few amazing books about the subject. One of his most famous works is Antifragile: Things That Gain From Disorder, where he argues that an effective investing strategy should strive to be antifragile: fully protected from total loss while still being open to the big return opportunities. From this, he forms what is called the barbell strategy.

“I initially used the image of the barbell to describe a dual attitude of playing it safe in some areas and taking a lot of small risks in others, hence achieving antifragility. That is extreme risk aversion on one side and extreme risk loving on the other, rather than just the “medium” or the beastly “moderate” risk attitude that in fact is a sucker game (because medium risks can be subjected to huge measurement errors). But the barbell also results, because of its construction, in the reduction of downside risk — the elimination of the risk of ruin.”

Illustration of the barbell strategy (by Mighty Knowledge)

The barbell (a metal bar that weight lifters use) is used to illustrate how we want to approach a balanced investing strategy. The main idea is that returns on investments are non-linear, especially at the extreme ends.

Very low-risk-low-return investments, like Certificates of Deposit (CD) or High-Interest Savings Accounts (HISA), are guaranteed to return your money at a set rate. The rate is typically very low because it is so safe. On the other hand, very high-risk investments have the potential to get you obscenely high returns. For example, Options contracts and Cryptocurrency might have the potential to return 100 times your investment.

According to the barbell strategy, being in the middle is the worst thing since the returns on your investment aren’t usually worth the risk. For example, you could invest in single blue-chip stocks like Coca Cola or General Electric, but your risk-reward tradeoff there is quite poor. The stocks of both companies might go down during economic downturns or when new competitors come into play. On top of that, such well-established stocks won’t be rising by 100X any time soon. In general, being in the middle does not give you a good balance of risk-to-reward.

Taleb eloquently sums up these ideas with a simple balance of 90/10:

“If you put 90 percent of your funds in boring cash (assuming you are protected from inflation) or something called a “numeraire repository of value,” and 10 percent in very risky, maximally risky, securities, you cannot possibly lose more than 10 percent, while you are exposed to massive upside. Someone with 100 percent in so-called “medium” risk securities has a risk of total ruin from the miscomputation of risks.”

Thus, the best and most antifragile strategy is to put 90% of your investment (whether time, money or something else) into safe things that are guaranteed. The other 10% goes into things that are highly risky, but also give you a chance to win big. You’re protected from losing completely while having exposure to the maximum amount of upside.

The precise numbers of 90% and 10% are guidelines, not hard rules. If you feel like you have a higher tolerance for risk or otherwise can withstand some hits, then feel free to increase your investment percentage in the high-risk-high-return assets. Vice versa of course if you prefer to play it safe. Just keep in mind the three key concepts:

Protect yourself from total ruin — majority investment here Avoid the unbalanced middle — no investment here Go for a few high-risk-high-reward bets — minority investment here