Dumbbell

What Is a Dumbbell?

A dumbbell investment strategy, otherwise called a "barbell" investment strategy, includes buying a combination of bonds with short and long maturities to turn out a consistent and dependable revenue stream. It is expected to offer the flexibility of short-term bonds notwithstanding the generally higher yields associated with longer-term bonds.

How Dumbbells Work

To carry out a dumbbell strategy, an investor would specifically purchase bonds with short-term and long-term maturities, keeping away from securities with intermediate terms. The thought behind this approach is to benefit from the best parts of both short-term and long-term bonds.

Commonly, long-term bonds offer higher yields, as compensation for the increased inflation and interest rate risks associated with the long-term structure. Then again, short-term bonds give investors more liquidity and thus less exposure to those risks. In exchange, short-term bonds generally offer lower yields.

By utilizing a dumbbell strategy, investors look to get an optimal balance of these two advantages. Assuming interest rates begin to rise, the short-term bonds can be reinvested into higher-yielding bonds when they mature. In like manner, on the off chance that rates fall, the long-term bonds will keep on giving a consistent and progressively appealing yield. One more advantage of this approach is that the investor's short-term bonds can be utilized to cover any unexpected large purchases or crises, while a portfolio of just long-term bonds would remain illiquid for a long time.

One of the disadvantages of the dumbbell strategy is that it must be actively managed, since the investor must consistently obtain new bonds to supplant their short-term holdings. On the off chance that interest rates decline, the interest income on the portfolio may not be adequately high to legitimize the extra time required to execute the strategy. Besides, the generally high volume of transactions makes the dumbbell approach more costly in terms of fees than other more passive approaches.

With regards to institutional fixed income, the strategies of utilizing "bullet" or "barbell" portfolios frequently have an alternate intent. This is on the grounds that the construction of various portfolios utilizing various maturities along the yield curve can each accomplish something very similar or comparative cashflows or yield to maturity (YTM) to the others.
What will change is the modified duration of those portfolios, an important measure of price sensitivity and risk exposure for large institutional holdings which means very little to the more modest investor. While an essential risk management apparatus for fixed-income experts, it basically affects more modest portfolios.

Certifiable Example of a Dumbbell

Dorothy is an effective entrepreneur who has as of late chosen to retire. In the wake of selling her business, she got a large cash position of $2 million. Anxious to generate a return on this cash, Dorothy chose to invest half of her cash holdings into a bond portfolio following the dumbbell investment strategy.

Dorothy chooses to invest half of her bond allocation, meaning $500,000, into short-term bonds with maturities of just 3 months. Albeit these bonds offer an extremely low interest rate, they offer Dorothy the chance to answer rapidly in the event that interest rates rise, allowing her to reinvest the proceeds into higher-yielding bonds upon expiration.

In addition, the bonds' short maturities mean that she will consistently approach her cash, diminishing her risk of illiquidity from crises or unforeseen expenses. For the excess $500,000, Dorothy invests in long-term bonds with maturities of somewhere in the range of 10 and 30 years. Albeit these bonds offer extremely limited liquidity, they additionally offer fundamentally higher interest rates than her three-month holdings, expanding the total income she can generate on her portfolio.

Highlights

• The dumbbell approach comprises of buying a combination of short-term and long-term bonds.
• It is something contrary to the supposed bullet approach, which includes buying bonds of intermediate maturities.
• The advantage of the dumbbell approach is that it can offer both somewhat high yields and reasonable liquidity.