Barbell investment strategy pros and cons

Recently I came into contact with the word ‘Barbell Investment Strategy’. The concept is not new to me but it’s the first time I’m reading it in detail.

What is it?

It’s an investment strategy suggested by Nicholas Nassem Taleb based on the success of betting against the market during the financial crisis.The basic idea is that ‘black swan events’, or events that are extremely rare, happens more often in financial markets. In other words, what we think as not risky may be riskier than we think. This experience is faced by some investors. An agent promised 8% return for some investment labeled as ‘normal’ risk, investor invested but did not get 8%. Sometimes, investor even loses money, it seems the reward doesn’t match the risk. And so a barbell investment strategy is proposed: avoid the moderate risk assets since its not working. Instead, invest in both low risk and high risk. The typical strategy is ~90% in low risk, 10% in high risk.

The pros of barbell investing

The advantage of investing this way is that 90% of our money is guaranteed to be safe even if a negative black swan event happen and everyone else loses their money. If a positive black swan event happens, the 10% of portfolio in high risk can get a good return and we can get an early retirement.

The cons of barbell investing

It is possible that high risk really is high risk and all our high risk money will burn in failure. There are approximately one hundred billion high risk investment options out there (just kidding), how do we know which one is the mispriced one?For high risk to work, we must take as many shots as possible, we put our eggs into many baskets. Tracking becomes a chore and we probably need to find new ones constantly as the old ones suffer losses. In the event our bet is successful, the other person need to payout. It is possible they can’t make the full payment promised because in the first place they never thought it will fail. Look at Lehman brothers, even AIG need a bailout. What if we won but can’t get a single cent?

Why do we invest? What is the appeal?

The main appeal of the barbell investment strategy as I see it lies in the bad experience of conventional investments.When investors lose money, or see their money stagnate in stocks/properties/unit trusts, it is not hard to dismiss it off regardless of the investment period. We live in a period of instant gratification; if we can pop a pill to improve our headache, surely there’s a pill we can pop to improve our investments. Why not follow an economist’s system used to score during the last crisis?

The takeaway

I guess Nicholas Nassem Taleb’s central idea in his writings (The Black Swan, Antifragile, and Skin in the Game) is that we should not always take data-driven mathematics and theoretical-economic systems as a complete investment strategies. We should link the numbers to ground reality: Is there a market? Is there a demand? Is there a business model? Or just a lot of assumptions and theory?I’m afraid this particular investment strategy might disillusion and disappoint 90% of the people implementing it without complete understanding. There’s a saying: ‘Do not be fooled by randomness’ – meaning that normal risk without link to reality may not be normal. It also extends to investment strategies that might work for a particular scenario but may not survive another real life condition.


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