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BACK IN 1987, Nassim Nicholas Taleb was a trader on Wall Street. But unlike most of his peers, Taleb wasn’t pinning his hopes on a market rally. Instead, he’d positioned himself to benefit from a market meltdown. On Oct. 19, just such an event occurred. For no apparent reason—in the midst of an otherwise strong market—the S&P 500 dropped 23% in a single day. The result: Taleb made a fortune—enough to retire at age 27.
How did he do it? The strategy Taleb used is known as a “barbell.” On one side, most of his portfolio was invested in extremely conservative government bonds. But on the other side, Taleb held a large number of option contracts. As its name suggests, an option is an agreement that gives an investor the option to buy or sell an investment at a particular price. A stock option, for example, might give an investor the right to buy a stock at $20 per share. In this case, the option would become valuable if the stock’s price rose above $20, because it would allow the option holder to buy the stock for $20 and then resell it for more.
In Taleb’s case, he held what are known as “out of the money” put options. This type of option gives an investor the ability to sell an investment at a fixed price. Such out-of-the-money options only have value in the event of a sudden and severe market downturn—a relatively rare event—so these options tend to be inexpensive. That allowed Taleb to load up on them at a modest cost.
On that day in 1987, when the market dropped 23%, these options suddenly multiplied in value. Options that he’d purchased for a few cents were now selling for as much as $5.
Because of stories like this, barbell investment strategies can seem attractive. As Taleb later described in his book The Black Swan, barbells allow investors to be simultaneously “hyperconservative and hyperaggressive” and thereby protect themselves from—and even benefit from—unpredictable risks like the 1987 crash.
Though it worked for Taleb, the strategy entails a few challenges. First, it’s complicated. Buying options requires both expertise and constant vigilance. And because option contracts have a limited life, an option can easily expire worthless, losing 100% of its value. The good news: You don’t need complicated and risky strategies like this to benefit from a barbell. There are other, simpler approaches.
The easiest might seem deceptively simple: If you own a combination of stocks and bonds, the result can be a very effective barbell. Over the past 10 years, the correlation between the S&P 500 and the bond market has been just 0.3 (on a scale where 0 represents no correlation and 1 represents perfect correlation). And that’s just the average.
In many years, the correlation between stocks and bonds has been negative, meaning that bonds have gained in value when stocks have dropped. We saw this between 2000 and 2002, when the market fell three years in a row. We also saw it in 2008, when the stock market plunged 37%, and we saw it again when the pandemic hit in 2020.
A variation on this strategy would be to combine stocks with cash investments. That can work, too. But because bonds have the ability to gain in price—and cash doesn’t—bonds tend to be more effective in a barbell.
That said, bonds can also lose value. To guard against that, you might diversify your bond holdings. You could, for example, hold a mix of short-term and intermediate-term bonds. While intermediate bonds gain more when rates fall, short-term bonds hold their value better amid rising interest rates. To further diversify this side of your portfolio, you could hold a mix of bond funds and individual bonds. However you structure it, the key is to make this side of the barbell as stable as possible.
Some people dislike barbell strategies because it means that part of their portfolio will, by design, be slower growing. That concern is understandable. To help overcome this concern, I suggest viewing bonds as insurance rather than as an investment. Bonds, in other words, aren’t there to make money. Instead, their role is to help your overall portfolio avoid losing money when the stock market is down. Just like a homeowner’s or auto insurance policy, bonds carry a cost, but they deliver an important benefit.
Beyond bonds, there are other ways to employ the barbell concept. Suppose you’re deciding when to claim Social Security. For each year you delay, between ages 62 and 70, Social Security will increase your monthly benefit. That’s the commonly cited reason for waiting. But there’s a barbell-related benefit, too: Because you’ll be receiving the largest possible guaranteed check from the government, you can afford to take more risk with your portfolio. That’s what Taleb was referring to when he talked about a barbell enabling an investor to be simultaneously hyperconservative and hyperaggressive.
Along the same lines, you could opt to annuitize a portion of your savings. That would also allow you to take more risk with the rest of your portfolio.
If you’re married, there’s another way you could use Social Security to help build a barbell: You could claim one benefit as late as possible, at age 70, and the other as early as possible, at 62. Strictly according to the calculator, this wouldn’t necessarily be optimal, but that overlooks the reality that none of us knows our own life expectancy. By claiming one benefit early, it can help mitigate this risk.
Barbells can be applied in other situations, too. Suppose you’ve benefited from one of the market’s highflying stocks, like Apple, Amazon or Nvidia, to the point where the shares now account for an uncomfortably large slice of your portfolio. One way to diversify this risk would be to add something like an S&P 500 fund to your portfolio. That would only be partially effective, though, because that fund would include the stock where you’re already overweight, thus increasing your exposure.
A solution to this problem would be direct indexing, where you’d purchase each of the stocks in an index individually. That might sound unwieldy, but there are services that automate this process. These services allow investors to tailor their portfolios in ways that aren’t possible with traditional index funds. In this case, you’d exclude the one stock you happen to already own, so you might buy just 499 of the 500 stocks in the S&P 500. That would be another sort of barbell—one that would help diversify your large overweighted stock position.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
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I’m more concerned with keeping some of the winnings of the stock market if there’s a crash. Maybe stop limit sell orders on VT and VTI.
It would seem the term “Barbell Strategy” can be used to describe a plethora of different portfolio structures.
I considered the writings of Dr. Wade Pfau and I replaced my Vanguard Bond Holdings with a series of FIA’s with Income Riders. As I see it, the purpose for holding bonds, as you alluded to in your article, is to provide safety and a uncorrelated asset offset, when paired with stocks, in the event of a market downturn. Annuities provide the same benefit, in addition to some others.
You also stated , correctly, that bonds can lose value. FIAs with Income riders do not, if used for their intended purpose.
Currently my annuities represent @40% of my portfolio, cash 5%, equities 55%. I am in the process of “shuffling” my current equity holdings from 80% VTI 20% VXUS, to a more growth & income focus, to include additional dividend income. I am awaiting the recommendations of a tax planning review before making the changes.
My wife and my SS, added to additional dividend income, will allow us to continue to let our FIA Income Riders grow in value and allow for the balance of our equity investments to grow as well, as we do not need to take withdrawals currently. When we need additional income, we will begin “turning on our annuity income,” on annuity at a time.
Love your articles. This was another good one.
I enjoyed reading all of Taleb’s books. He presented many interesting ideas, but his math is over my head. Thanks for simplifying it. I have read numerous articles by experts discussing the same topic and who typically give similar advice. While this may seem repetitive, I appreciate being reminded of timeless advice especially when headlines are screaming about some impending financial disaster. I can memorize good advice but if I grasp the reasoning behind that advice, I may find it easier to “stay the course” when markets go crazy. One of your gifts is that you can cover a well worn topic, but provide a unique analogy I hadn’t encountered before, which helps me to really grasp the idea, one that “resonates” with me.
Adam, thanks for a great article. I never equated some of the strategies you describe as “barbell” strategies, but it makes sense. Similar to considering bonds as insurance, I’ve come to think of SS as insurance, not an investment. The word insurance is in the official title – Old-Age, Survivors, and Disability Insurance.
At an age when a good night’s rest is harder to find each night, a pile of Treasurys, short and intermediate, nominal and inflation-indexed, are indeed a powerful sleep elixir.
For me, options have been a useful insurance tool to manage stock grants through the first years of retirement.
Thanks, Adam, for this take on “insuring” one’s assets. I view bonds as portfolio insurance and they help me sleep well at night. I like also that, with muni bonds, I help finance community infrastructure and low income housing.
Adam – your analogy of helping your clients to see bonds in their portfolio as a type of insurance was pure gold. So simple, yet the example resonated with this reader. Alternative “barbell” strategies using S&P and even when claiming SS benefits as a couple and/or annuitizing a portion of your retirement savings to allow for greater market risk elsewhere in a portfolio – these little nuggets were also quite helpful. A solid article (as is the norm). Thank you, sir!
Agreed!
The insurance analogy is helpful to me to understand a stock and bond barbell. Knowing I have enough “safe” money set aside for my needs let’s me take market gyrations in stride.