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A barbell strategy for stocks

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AUTHOR: billehart on 6/27/2024

Adam Grossman recently wrote a good piece about “barbell” strategies.

A barbell—literally—is a metal bar with weights on each end like you see in a gym or an old Popeye cartoon. There are no weights in the middle, just on the opposite ends.

In investment terms, a to implement a barbell strategy is to overweight assets at opposing ends of the spectrum. A common approach is to create a barbell of bond funds with short-term maturities and those with long-term maturities and not much in the middle. That’s an alternative to another common strategy of mainly investing in the middle—intermediate-maturity bond funds.

But you can do something similar with stocks. I recently created a sort of barbell with small-cap value and large-cap growth funds. (Although I do still have a lot in between, including in broad index funds.)

Readers may recall my unfortunate predilection for small-cap value. I say unfortunate because the relative performance of cheap small stocks has trended down for nearly 15 years, despite their outperformance over longer periods. Over 15 years, the Vanguard 500 Index Fund is up more than 681% while Vanguard’s small-cap value index offering has gained just 471%. On an initial $100,000 investment, that’s a crushing shortfall of $210,000.

I’m too close to retirement to risk that kind of opportunity cost by betting too heavily on one segment of the stock market. Yet I have a gain in the Vanguard Small Cap Value Index ETF (symbol: VBR), which is in a taxable account. I don’t want to incur capital gains taxes just to reduce small-cap exposure when small-caps could be poised for a bounce back.

But I’ve been feeling real pain in the past few years.

I finally decided to hedge my bets. In March, I shifted some money from a total market index fund in a retirement account to the Vanguard Growth Index ETF (symbol: VUG). My position is about half of my position in the small value fund, so it’s an uneven barbell. Compared to the world stock index, I’m still underweight in stocks like Apple, Microsoft and Nvidia, which I want to be.

It’s been a psychologically positive move. When I look at my portfolio, one or the other side of my barbell is doing well. Small-cap value outperformance vindicates my overweight; continued large growth dominance makes me feel relieved that I hedged my bets.

Taking such an approach means I have less weight in the middle—all the stocks in between small value and large growth. I risk not fully participating in a large-cap value or mid-cap move, for instance.

But until I can take profits in small-cap value with more limited tax impact—such as after I retire—and put the proceeds into my index funds, the barbell approach works for me. Given my worries about small value’s underperformance, the barbell strategy has—ahem—taken a weight off my shoulders.

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