Barbell Investing: How to Maximise Profit while Protecting Your Capital?

In this post, we will discuss how to maximise profit while protecting your capital. 

There are many strategies that claim to maximise profit while protecting your capital. Personally, I have tried several and adopted some for my own portfolio. 

One strategy that I find particularly useful is this strategy known as the “Barbell Investing” by Nassim Taleb.

There are many variations of Barbell Investing but I find Taleb’s variation to most logical in terms of risk management and easiest to implement.

In short, the strategy is to invest in the extremes of investment spectrum. In any investment, it is always characterised in terms of its Risk and Rewards. 

“The higher the risk, the higher the rewards”

What is Barbell Investing?

Barbell Investing takes this idea to extremes, and it states that your portfolio should only invest in extremely-safe and extremely-risky assets. Hence, your portfolio will look like a barbell, investing at the ends and nothing in the middle. 

The overall idea is “Invest the majority of your portfolio in almost risk-free assets to protect against any crashes, while invest the remaining in high growth potential investments where your upside is unlimited.”

Let’s start with the majority side of the barbell. 

By investing 80-90% of your portfolio in extremely safe assets, your capital is protected, even if the remaining 10-20% is wiped out by some freak Black Swan event. This is what Taleb calls Antifragile. In addition to being well protected during a crisis, your portfolio might actually outperform the market as extremely safe assets tend to perform better during economic downturn.

What are Extremely Safe Assets?

While Taleb did not specify in his book, I would suggest the following as extremely safe assets:

1. Government bonds that are rating AAA
2. Gold
3. Rental returns from a well-diversified and well-managed REIT
4. Real Estate that generates healthy rental returns

While these assets do not provide very high return, they are likely to hedge against inflation. Most importantly, these assets have proven to hold well against economic crisis.

What are Extremely Risky Assets?

While it is hard to identify safe assets, it is very easy to find risky assets. It can be anything from high growth stocks to cryptocurrencies. Hence, you must choose carefully.

To choose the ideal risky assets for your barbell portfolio, you must ask these questions:

1. Is there foreseeable future potential for this asset? (e.g. do you see a future where this asset will be extremely valuable?)
2. Do you understand this asset enough to invest in it? (it is likely that the price of this asset will fluctuate greatly, you need to understand the asset enough to withstand the volatility.)

If you can answer “Yes” to both questions, this risky asset might be ideal for your portfolio. The key word is MIGHT.

What are the Possible Outcomes on a 90-10 Barbell Portfolio?

1. Your bet on the risky assets went well. 
   1. In this scenario, your risky assets went through the roof and provided high returns (e.g. more than 300%). The majority of your portfolio will remain the same as they are not affected. 90% remain intact. 
   2. Your total return will be 90%+ (10 x 3)% = 120%
   3. 20% profit!
2. Your bet on the risky assets went poorly.
   1. In this scenario, your risky assets crashed and burned. While the majority of your portfolio remains unaffected. 90% remain intact. 
   2. Your total return will 90%
   3. Maximum 10% loss!

In the scenarios above, while the 10% loss is maximum, the upside is theoretically unlimited, your aggressive bet on risky assets could return more than 300% (e.g. 500% or 1000%).

Why I Like This Strategy?

At first glance, this strategy seems very dangerous as it invests in risky assets. However, it is limited to just 10% of the portfolio. Therefore, the majority of your investment remains “safe” or as I call it, “You are still in the game.”

The other important aspect of this strategy is that it can be relatively passive, as you do not have to monitor the safe assets too often. As for the risky assets, you are taking small speculative bets hence you may choose to “bet and forget” as the downside is limited. 

What is the Downside of this Strategy?

This strategy will likely underperform in a rising bull market like the one we are experiencing for the last 9-10 years as the general stock market has been on the rise, while safe assets such as gold and bonds have provided little returns. 

What Would You Do?

After understanding what is a Barbell Portfolio, do you find it suitable for you? Do let me know your thoughts and how you might use it! I hope this has been useful for you! Once again, this is not an investment advice or recommendation!