DEFINITION of 'Dumbbell'
A dumbbell method of investing in bonds ensures the majority of an investor's portfolio consists of short-term, low-risk bonds and a small percentage of high-risk, long-term bonds. A dumbbell allows investors to split his risk between high- and low-risk investments while capitalizing on the highest possible returns.
Also called the barbell strategy.
BREAKING DOWN 'Dumbbell'
A dumbbell method of investing involves buying short- and long-term bonds with varying maturities to provide steady, reliable income. If an investor has too many bonds maturing at the same time, rates may be down when the principal is repaid, which can affect the investor’s income. Holding too many long-term bonds exposes risk of lost income due to rising interest rates. Diversification is needed for longer-term bonds to lock in higher interest rates and provide more income, while shorter-term bonds provide more flexibility for investing in other securities if rates drop. When interest rates rise, short-term bonds held to maturity are reinvested at higher interest rates for greater income. For example, an investor buys two long-term bonds and two short-term bonds and takes advantage of high long-term interest rates. When the short-term bonds mature and the investor receives the principal, he invests in more bonds if interest rates are high enough to meet his targeted income, or in a more liquid asset if he thinks rates may rise in the near future. The investor continues receiving interest payments from the two long-term bonds.
Advantages of the Dumbbell Method
The dumbbell method typically outperforms the stock market, so an investor has the potential to earn more regular income than a stock could provide. The strategy lets an investor take advantage of higher interest rates and minimize risk without limiting financial flexibility. Since some securities mature every few years, the investor has the liquidity required for large purchases and emergencies. Putting part of a fixed-income portfolio in long-term bonds reduces the risk of increasing interest rates that affect the value of securities with longer maturities. Once this strategy is started, it must be actively monitored so new bonds replace mature ones and continue providing regular income.
Disadvantages of the Dumbbell Strategy
The dumbbell strategy takes time and must be constantly tracked to attain desired results. An investor may have to wait for other securities to mature before utilizing this method. Monthly income is not guaranteed to reach an investor’s goals. Purchasing multiple bonds is more expensive than purchasing one, and potential returns may not justify the additional cost. Risk is not eliminated completely.