How to Use the Barbell Strategy to Diversify Bond Investments
Realize that you have options when it comes to investing in the bond market., Research which type of bond is right for you., Realize that while your money is out of your hands for a much longer period, the long-term maturities will provide a higher...
Step-by-Step Guide
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Step 1: Realize that you have options when it comes to investing in the bond market.
Many people think that all bonds are basically the same and therefore diversification is not as important as with stocks.
Nothing could be further from the truth.
There is a wide variety of bonds, ranging from government T-bills to municipal (muni), corporate or even zero-coupon bonds.
You will want to diversify by investing in each of these categories as well as within any single bond type.
There are two main strategies for diversification in the bond market.
The ladder strategy involves dividing an investment into various bonds that mature at regular intervals.
An example is six months, one year, 18 months and two years.
In this example, a bond matures every six months.
The advantages are consistent returns and liquidity.
Another benefit is that since these maturities are "staggered" (or "laddered"), the chances are slim that all the bonds would be called at the same time.
The barbell strategy consists of dividing a bond investment into very short-term and very long-term maturities.
The advantage is that one portion of the portfolio should return high yields, while the other portion would involve very low risk and be relatively easy to liquefy. -
Step 2: Research which type of bond is right for you.
In general terms, muni bonds work really well using the barbell strategy.
However, just as in the stock market, the ultimate choice is yours.
You should go with a bond type that you have confidence in. , Muni bonds have a low risk of being called and are therefore good choices for your long- term bonds. , Your short-term bonds will allow you to take advantage of the changes in interest rates.
They provide peace of mind should you need to liquidate in an emergency. , Do not make the mistake of thinking you can just forget about them.
Once they have aged to half of full maturity, re-evaluate them.
Based upon the prevalent interest rates on long-term bonds, the early-withdrawal penalty might be offset or even surpassed by a really good rate on another long-term bond.
Consider selling and reinvesting your long-term holdings. , Your longest bonds should be ten years, and re-evaluate this position in about five years. , -
Step 3: Realize that while your money is out of your hands for a much longer period
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Step 4: the long-term maturities will provide a higher rate of return and will increase in value over this time.
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Step 5: Evaluate your portfolio often.
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Step 6: Keep your eye on your long-term maturities as well.
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Step 7: Start your barbell strategy with a 50-50 split between long-term and short-term maturities.
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Step 8: Remember that longer-term bond prices normally decline whenever prevailing rates are rising.
Detailed Guide
Many people think that all bonds are basically the same and therefore diversification is not as important as with stocks.
Nothing could be further from the truth.
There is a wide variety of bonds, ranging from government T-bills to municipal (muni), corporate or even zero-coupon bonds.
You will want to diversify by investing in each of these categories as well as within any single bond type.
There are two main strategies for diversification in the bond market.
The ladder strategy involves dividing an investment into various bonds that mature at regular intervals.
An example is six months, one year, 18 months and two years.
In this example, a bond matures every six months.
The advantages are consistent returns and liquidity.
Another benefit is that since these maturities are "staggered" (or "laddered"), the chances are slim that all the bonds would be called at the same time.
The barbell strategy consists of dividing a bond investment into very short-term and very long-term maturities.
The advantage is that one portion of the portfolio should return high yields, while the other portion would involve very low risk and be relatively easy to liquefy.
In general terms, muni bonds work really well using the barbell strategy.
However, just as in the stock market, the ultimate choice is yours.
You should go with a bond type that you have confidence in. , Muni bonds have a low risk of being called and are therefore good choices for your long- term bonds. , Your short-term bonds will allow you to take advantage of the changes in interest rates.
They provide peace of mind should you need to liquidate in an emergency. , Do not make the mistake of thinking you can just forget about them.
Once they have aged to half of full maturity, re-evaluate them.
Based upon the prevalent interest rates on long-term bonds, the early-withdrawal penalty might be offset or even surpassed by a really good rate on another long-term bond.
Consider selling and reinvesting your long-term holdings. , Your longest bonds should be ten years, and re-evaluate this position in about five years. ,
About the Author
Roy King
A seasoned expert in education and learning, Roy King combines 5 years of experience with a passion for teaching. Roy's guides are known for their clarity and practical value.
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