Explaining a Barbell Portfolio

I get frequent questions about my personal portfolio, especially the trend following portfolio in my non-registered investment account. One of the questions I get is why I don't use the Leveraged Barbell Portfolio strategy that I talk about in the blog.

My answer is that I do use a leveraged barbell portfolio strategy in my non-registered account. It's simply not as passive as the strategy I shared.

A barbell is an iconic, effective, and simple piece of weightlifting equipment. The lifter loads a 220 cm bar with an equal number of iron plates on each side to the desired total weight.

If you look at the loaded bar lengthwise, it is mostly just an empty bar. But that weight on the extreme ends of the bar can weigh hundreds of pounds. A small part of the total bar carries all the weight!

An investor could break down this same idea into an investing concept. Most of a barbell portfolio is invested in pretty boring assets that generate a reliable, moderate return.

However, like the ends of the barbell, a smaller amount of the total portfolio is invested in risky assets that can generate large returns and does the heavy lifting for your portfolio.

The barbell portfolio tries to minimize big losses, provides great risk control, and the investor has the opportunity to experience great returns.

Barbell Portfolio Structure

Safe Assets

In a barbell portfolio, 60 to 90 percent of the portfolio should be invested in safe assets. We are looking for stability and security with dependable returns.

Of course, the returns for assets with these characteristics won't be that high. Even 2 to 3 percent real returns (4 to 6 percent gross nominal) are okay here.

The exact amount of safe assets you choose should depend on what you use for your risky assets and your overall risk tolerance.

A portfolio with just 60 percent in safe assets could see a 40 percent decline.

Some examples of good safe assets include:

  • Broad bond funds (AGG, BND, XBB.TO, HBB.TO)
  • Short-term government bonds (SHY, VGSH, XSB.TO, VSB.TO)
  • Short-term corporate investment grade bond funds (IGSB, VCSH, XSH.TO, VSC.TO)
  • Intermediate-term government bonds (IEF, VGIT, XGB.TO, ZGB.TO)
  • Split bond portfolio (half short-term bonds, half long-term government bonds)

Risk Assets

The remaining 10 to 40 percent of your portfolio will be invested in risk assets. On this side, we are looking for high period returns.

The assets invested in here should, at minimum, have shown themselves to double in value in a year or less on several occasions in the past.

The precise assets you use will depend on your overall risk tolerance and your allocation to safe assets. If you are allocating 40 percent of your portfolio to risky assets, you should choose less extreme options.

Some examples of potential high return assets include:

  • Leveraged ETFs
  • Options
  • Small cap stocks
  • Technology stocks
  • Biotech stocks
  • Private equity
  • IPOs

Principles

Always protect your portfolio! Commit to a very hands off approach with your safe asset allocation and do not pursue outsized returns here. You do not want to lose this money.

Generally speaking, the higher your allocation to the safe assets is, the more durable and stable your overall returns will be. While a modified barbell portfolio might contain just 60 percent safe assets paired with a 40 percent exposure to a leveraged index fund, a true barbell portfolio would have at least 80 percent safe assets paired with the highest risk choices like options.

Leveraged Barbell Portfolio

In the Leveraged Barbell strategy which I so enthusiastically share on this blog, I talk about an extremely passive method for employing the barbell strategy.

Using leveraged ETFs and short-term bond ETFs, you only need to adjust your portfolio allocation once per year. That's as easy as the Couch Potato strategy, but your returns and protection are better.

Since the Leveraged Barbell Portfolio I share uses broad equity index ETFs, the 3x daily leveraged S&P 500, you can safely allocate higher amounts to the risk side. Still, I would recommend the average investor allocate between 60 and 70 percent of their portfolio to bonds.

My Leveraged Barbell Portfolio

Knowing that a barbell portfolio is one mostly invested in safe assets with a smaller allocation to risk assets, you will see that my trend following portfolio is actually a leveraged barbell portfolio.

In my trend following portfolio, I track U.S. equities, developed international equities, emerging international equities, gold, silver, and currencies.

Safe Assets

Currencies can be thought of as a safe asset in many ways. I do not use any leverage when making bets on currencies, they are easy to trade on the upside or downside as currencies are pair-traded, and the markets are extremely liquid and price efficient. I also take pretty small positions on currencies.

I use currencies, including the U.S. dollar and Canadian dollar, as they are more flexible and tax efficient than investing in bonds in my non-registered account. I would rather earn capital gains than interest income.

To get some perspective on my current position, I am a little over 90 percent in currencies at the moment. Most of that is U.S. dollars.

Risk Assets

I use leverage to invest in each equity and commodity position. This was done with leveraged ETFs and I am going to start using LEAPS options for more efficient capital use.

As I slowly get out of the last of my leveraged ETFs and the market begins to send upside signals on equities, I will be investing via LEAPS options only. It is likely that my portfolio will rarely be more than 20 percent allocated to risky assets.

I am very cautious about shorting (betting against) many assets, particularly equities. It is extremely difficult to short equity index funds and make money. This means I will primarily only bet on the upside signals for equities; when the signal is down, I will be in cash.

I see potential for upside and downside bets on gold and silver when using LEAPS options. This means as I get my LEAPS options trading going, I may be invested in gold and silver calls or puts at all times, depending on the signal and sized based on volatility.

In effect, this will be a barbell portfolio where the risk assets (up to about 20 percent of the portfolio) are LEAPS options that are entered or exited based on trend following signals.

Comments & Questions

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13 Replies to “Explaining a Barbell Portfolio”

  1. “I use leverage to invest in each equity and commodity position. This was done with leveraged ETFs”

    Why leveraged ETFs as opposed to margin? With margin you can deduct the interest and you don’t have to worry about the daily reset of the leveraged ETFs. Thanks.

    1. Daren (Editor) says:

      I did leveraged ETFs and regular ETFs with margin. Some of the leveraged ETFs like UPRO and TQQQ are so liquid it doesn’t really make sense to take margin loans and buy SPY or QQQ. Others, like EFA don’t have a good leveraged ETF option so margin is a must. As I’ve shared in prior posts, the daily reset scare is very overblown on broad index funds.
      Also, with GLD or SLV there are no distributions, so I can’t write off the margin interest. Better choice is UGLD or USLV.

  2. Why LEAP options as opposed to regular options? Thanks.

    1. Daren (Editor) says:

      Longer holding periods, less turnover, and less time decay costs. It’s a better fit for long term trend investing.

  3. Thanks for your feedback Daren.

  4. Ah, other question if you please. Would it make sense to use DM in the risky portion of a barbel portfolio? Say 70% is in short them bonds and the remaining 30% is invested in 3x leverage ETFs as per signaled by DM?

    1. Daren (Editor) says:

      Sure, it is effectively a form of trend investing in the risk portion. As long as you commit to 3x leveraged ETFs so they have the necessary high potential return.

  5. In this case I see 3 options when DM signals to get out of equities:

    1.) sell the 3x leverage equity ETF and whatever I get keep it as cash.
    2.) sell the 3x leverage equity ETF and whatever I get use it to buy a 3x leverage bond ETF.
    3.) sell the 3x leverage equity ETF and whatever I get use it to buy short term bonds (of the same kind of the safe portion of the barbell).

    I am inclined to think 3 is best; but this is just my gut feeling. In any case there might not be much left to sell when DM signals to get out: a 10% drop would have wiped all the risky portion. What do you think?

    Also, in a situation where the risky portion goes to zero we need to rebalance; but I am not sure how. Do we rebalance once a year no matter what, or do we rebalance when DM signals to go to back equities? (Let’s assume free trades)

    Thanks for the wisdom!

    1. Daren (Editor) says:

      I would be inclined to look at option 2: the leveraged bond ETF. The reason is that most of your portfolio is in very safe assets, so why not have some risk somewhere based on a sound process. It won’t always win, but it might.
      The math on your DM signals with a 3x leveraged ETF is a little off. Lets use your example with 70 percent of your portfolio in short/intermediate bonds and 30 percent in a 3x leveraged ETF. If the stock market drops 10 percent and kicks you out of your position, your portfolio will have dropped by roughly 10 percent as well: 0.3*(0.1*3). In dollar terms, a $100,000 portfolio is $70,000 bonds and $30,000 leveraged ETF. The leveraged ETF falls 30 percent (10% * 3), that’s just a $9,000 loss. Your bonds are still $70,000 and your risk portion is now $21,000 for a total portfolio of $91,000. (Of course it will be slightly different because of daily rebalancing.)
      I would re-balance every time the signal changes, but no more than once every 6 months. Typically that will be shifting money from risk to safety, but sometimes the other way around. The 6 month thing would prevent your safe assets from being eroded by a whipsaw situation.
      Following this methodology, your portfolio would have returned roughly 10.6 percent CAGR from 2010-2018.

  6. What was I smoking when I did that math? Thanks for the correction Daren and for the other explanations.

  7. Hi Daren. I cannot get this out of my head. If/when you can, please give us your opinion.

    You prefered Option 2 above. Let’s consider how that would play today. Interest rates are rising and DM could send us to bonds soon. Say we are indeed sent to bonds and that the FED keeps hiking (I think I read somewhere they might be just in the middle of the normalization cycle by some estimates).

    I don’t know of any short term leveraged ETFs. I know of middle term maturity like TYD and long term maturity like TMF. I cannot help but think it would be a mistake to go to TYD/TMF in the current environment. That is why I prefered option 3 above.

    What do you think? Thanks.

    1. Daren (Editor) says:

      I’m thinking of two main considerations. First, 70 percent of the portfolio is already in shorter term bonds. Second, in my recent DM Bond post it clearly shows long term Treasuries (TMF) and 10 year Treasuries (TYD) having the best overall performance since the late 1970s. This includes a major rising rate period.
      Your premise appears sound if you listen to the talking heads, but the data seems to suggest otherwise. This time might be different, but you do have that 70 percent shorter bond backstop.
      Interestingly, a mix of short term and long term Treasuries rebalanced regularly does perform very well.
      For a bond portfolio one could also make a strong case for mixing TIPS and long term Treasuries. TIPS protects from inflation, long term Treasuries protects from rate drops.
      If you look at the Fed rate history it seems to be a pattern of slowly up, quickly down. I would bet they raise rates until a few real economic hiccups hit, then they cut aggressively.

  8. Thanks for the input Daren!

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