My Take on the Barbell Investment Strategy

In the post Meet Nassim Nicholas Taleb, I dropped in this quote without adding any comments.

the good investment strategy is to put 90% of your money in the safest possible government securities and the remaining 10% in a large number of high-risk ventures. This insulates you from bad black swans and exposes you to the possibility of good ones. Your smallest investment could go convex explode and make you rich.

Do I support this investment strategy? My short answer is it depends. Taleb has two variables isolated in this quote.

  1. Percentage of money allocated to the safest investment. (90%)
  2. Percentage of money allocated to high-risk ventures. (10%)

Let me add my own personal 3rd variable:

Are we in a secular bear or bull market?

Once you determine if the current investing environment resembles a secular bull or bear market, then you can adjust your definition of safest. If the conditions indicate a bull market is more likely then having 90% of your investment tied up in low yielding government debt seems foolish. If the market is range-bound or in a secular bear market then the goal is preservation of capital not appreciation of capital. As I explained in my post Mr. Financial Planner – Go Home and Get Your Shine Box! there is nothing wrong with near-cash investments in this market environment.

What makes Taleb interesting today is many investors now see the secular bull market from 1982-2000 is not coming back anytime soon. The mantra of Investing in Stocks For the Long Term is historically a fools move in a range-bound or secular bear market. But we still want the possibility of making a lot of money while preserving most of our capital. Hence the barbell strategy.

Taleb has spent the last twenty years on Wall Street so he has ample time to think about how to deploy his 10% on high-risk ventures while having the peace of mind knowing that 90% of portfolio is safe. Most investors will be ill-equipped to measure the risk versus reward to exploit those opportunities.

Learning how to spot under-valued investment opportunities that although risky provide a huge potential payout is something I’m interested in exploring. That statement is not an invitation to promote your business in the comments below. I’m more interested in discovery methods than the actual discovery.


Add yours

  1. Briefly, I’m an ‘old school’ investor who likes to keep it simple: (a) “there are no risky investments, only risky investors” and (b) “invest only with insider information”. “Insider information” here doesn’t mean illegal information. It means know the ins and outs of an investment: the ‘inside” being the financials of the investment and the management team behind the investment; the ‘outside’ meaning the market FOR THAT SPECIFIC INVESTMENT.

    The first part above — “only risky investors” get to the “stick with what you know”. For example, if you know a lot about vaccuum cleaners, like the financials of the company and like the management team of a certain company that manufacturers vaccuum cleaners invest in that vaccuum cleaner company and go ‘all in’ (i.e. put a lot of your capital there). I also want to have a lot of control over my investment (probably over 75% of my liquid capital is in investments that meet the above criteria): (1) something I know, (2) something I have insider information about, and (3) something I directly have major control over. The rest of the 10% can go into very passive stuff like money markets, mutual funds, Roth, etc.

    Finally, I believe there is a risk spectrum generally and also within an asset type and within asset subtypes. For example, for me, I’m a real estate guy, so 90% of my money is in real estate but cash flowing retail and apartment real estate (passes the first three tests — I know it, have insider information, and control the investment). But, real estate DEVELOPMENT is a risky investment for me. So, I may have 80% of my 90% in real estate but in retail and apartments cash flowing real estate and the remaining 10% in ‘forced appreciation’ deals such as development …


  2. I know some people who are very good at what they do (i.e. say biotech or software) that might be very successful at this, but most of us are competing directly with MANY analysts on Wall Street who have access to way more info than we do …and do this as a day job.

    The idea that Joe-6-Pack is gonna pick a 1000-bagger with 1% of his portfolio seems ludicrous …yet that would only increase portfolio size 10 times …maybe over 20 years.

    On the other hand why would you want to tie up 90% of your capital on bonds in a Bull market?? If you threw 10 darts at the WSJ in 2002 and invested 10% in each company …then sold in 2007, you probably would have doubled your money!

    The key …in my humble opinion …is to be fully invested in equities in Bull markets …and in some combination of short equties, cash or bonds in Bear/Sideways markets (depending on how well you want to sleep at night).

  3. Final note …there are ways to determine bear versus bull that I’ve posted previously. The two most common:
    – Buy/sell equities when the 200DMA crosses the 50DMA +/- 1%.
    – Buy equities when PEs go below 10 and sell equities when they go above 20 or so.

    By the way …if you shorted the S&P at the 50/200 “death cross” you would have made 10% to date and would never have gone under water. Double shorts of course would have generated 20% since November.

  4. Maybe a single post wasn’t enough to fully explore the barbell strategy. A key point Taleb hits on is the concept of undervalued unexpected outcomes. The keyword being undervalued. By exposing a small percentage of our investment to the possibility of a positive Black Swan, while protecting the bulk of our money from a negative Black Swan – we can come better.

    In one of his two books, he goes into detail on how human biology sets us up to undervalue situations which can make us rich or break us.

  5. Jim – I agree with your rules on how to leverage the “safe” portion of your portfolio. I did a post on the 50/200 rule here:

    Simplest Investing Rule

    I think my goal will be to use simple rules and history to manage 90-95% of my investments and then seek out undervalued unexpected opportunities with higher payoffs for that last 5-10%.

    In 2006, John Paulson made a billion dollars when he learned how to short subprime debt. In retrospect it was so obvious, but it was an outcome with a huge payoff that very few people were exploring.

  6. Here is a post from someone who has done well by reading The Black Swan. I am a “newbie” still learning and open to new strategies from others on this site, even from those who don’t agree with the premise.

    I sold all my shares after a desire to protect my 27% total portfolio gain (mostly luck) in 2007, but mainly after reading the Black Swan, which convinced me of the risk in the market using past history as a guide. I have been sitting 90% on government secured debt since, and escaped the recent downturn.

    Of the remaining 10%, half was put into biotech stocks over a 4 month period starting in January 2008. I purchased a flat equal amount of any listed non-penny stock that billed itself as using biotech to seriously pursue major cures (cancer, obesity, heart disease, etc.). That portfolio of over 100 stocks that was purchased mostly before the market crashed is down less than 5% (as of April 14, 2009). My goal here was to increase my exposure to positive black swans. There is no way of knowing which 2, 5, or 10 of theses companies will make major discoveries in the coming decade. But when they do, my assumption is they will swallow up a multiple of their number of similar companies from the same universe in order to keep the engine of research humming.

    I am gradually “bleeding” the other half (5% of my total portfolio) into way out-of-money options.
    These are small $300 bets on a huge up or downswing to a particular stock/industry/ or the total market. Most of these “lottery tickets” or “insurance payments” are destined to expire worthless. It has been fun watching some of these come close to breaking even, some even tripling in value before they break back down. My hope is to eventually make $5 to $50 per share on something that cost me 10 or 20 cents, thereby turning a $300 investment into something much larger.

    I didn’t “get” options and start trading them until late 2008, so I didn’t take advantage of the downturn in financials over the past year (rats!).

    Some examples of my $300 lottery tickets which expired worthless:

    Betting that oil would dramatically come back up or the economy would quickly improve by buying out of money calls on oil companies out 6 months.

    Betting that the market would drop further by buying puts on Disney out three months. I like using Disney to bet against the market, I think canceling a Disney cruise vacation is an easy thing to do when you lose your job. On the other hand, Disney makes lots of money on cheap entertainment (videos, etc) so I am looking for better ideas here as well.

    Current Bets, repeats of the above, plus:

    Jan 2011 Calls on prudent (non-toxic) mostly regional banks – – I am betting that they will benefit from the coming inflation (once confidence returns). Banks earn much higher spreads during periods of high inflation.

    Jan 2010 Calls on Interoil, largest discovery of natural gas in many years in Papua New Guinea close to far-east markets (Australia, China, etc.). This is a unique “story” stock that may also play well into a general market recovery.

    I am posting here because I hope to get more ideas. You may not agree with the Black Swan/barbell approach. But if you have ideas like those above for “lottery tickets”, or “insurance premiums” to hedge against risk in a stock portfolio, I would be interested in discussing!

    Do you have any good tips/rules of thumb for purchasing way out-of-money options in order to protect or increase your portfolio?

    (Sorry for the long post, love your photograph!!!)

  7. Joe D. – Great post.

    Currently I am not in a barbell strategy – but hope to be at some point. To me there seems to be a lot of pressure building up for a downside plunge. Once I think fair market valuations have returned, I will move more toward that barbell.

  8. This article offers a few clues as to how the strategy was applied at Empirica…

  9. Regarding changing the safe investment part of the portfolio based on whether there is a secular bull or scular bear market going on, one of Taleb’s points is that we can’t predict when there is (or will continue to be) a bull or bear market. Guessing that you are in a bull market puts your”safe” money at risk of a negative Black Swan, so it risks the entire investment strategy. As Taleb points out, we humans are programed to get antsy at the “risk” of getting returns that are too small when others are benefiting from a bull market. You seem to advocate giving voice to this negative urge.

  10. @thatcar – The one thing that I have been very poor at modeling in the past year or so is the endless rules changes and lack of enforcement of existing laws. I still have a bearish view, so I’ve aligned my investments accordingly. The flaw with the barbell strategy in my view is it requires to much starting capital. I hope to be there one day.

  11. Along the lines of the Empirica strategy discussed in gogol’s link . . . .

    Perhaps we could brainstorm individual stocks that would be good candidates for put opion “lottery tickets” that would pay off BIG if there were a huge downturn.

    Stocks that . . . . .

    a) are overvalued.
    b) have a history of doing especially poorly when the market tanks.
    c) have out of money put options which are cheap.

    A cheap put option could cost 20$ per contract (100 shares), would likely expire worthless, but if there were a huge 911 style shock may pay off hundreds or thousands per contract.

    In addition, if the stock behind the put had its own negative black swan event, the payoff could be just as big without a general market-wide downturn.

  12. I’m posting an extended response to Taleb’s bar-bell nonsense here:

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