The Art and Science of Return Stacking, Ep #83

Upthinking Finance™ is now trademarked The enduring wisdom of financial planning often revolves around diversification(1). Yet, as highlighted in this episode of Upthinking Finance™, the ways we balance portfolios—and the very assumptions underpinning traditional advice—may be overdue for review. We’re focusing on the critical importance of risk management for investors, especially in the years leading up to retirement, and on how past market conditions may not reflect what lies ahead. My guest, Mike Philbrick, shares his thoughts on the shift from decades of falling interest rates and stable inflation to a more volatile environment marked by rising rates, inflation shocks, and evolving global dynamics. He believes that investors should move beyond traditional stock and bond portfolios by embracing greater diversification—including exposure to commodities (2), global assets, and alternative strategies like trend following and return stacking. (1) There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.(2) The fast price swings in commodities will result in significant volatility in an investor’s holdings. Commodities include increased risks, such as political, economic, and currency instability, and may not be suitable for all investors. The End of a 40-Year TailwindThe last four decades have been a period largely defined by falling interest rates, disinflation, and economic globalization. These conditions created a supportive backdrop for the classic 60/40 stock-bond portfolio. When stocks faltered, bonds often thrived, offering consistent dampening of volatility. This yin-yang dynamic established a pattern of reliable returns and relatively muted drawdowns for balanced portfolios.However, the recent shift—marked by rising interest rates, surges in inflation, and increasing geopolitical fragmentation—has upended this familiar regime. Not only have stocks and bonds begun to move more closely together, but bond investors have faced a five-year bear market. For anyone banking on the playbook from the last 30 or 40 years, the past few years have been a wake-up call.Recognizing and Addressing Portfolio Blind SpotsOne concept we discuss is the implicit risk of overreliance on market-capitalization-weighted indices such as the S&P 500. Historically, dominant sectors and companies shift dramatically within these indices. In 2008, Exxon was the largest S&P component, only to be eclipsed by technology firms in recent years. Today, the S&P 500 has minimal exposure to commodities and natural resources, even though these sectors can play a crucial role during certain economic cycles.A key theme that emerges from our discussion is the importance of true diversification—not just across stocks and bonds, but also across economic regimes (rising vs. falling growth and inflation), sectors, geographies, and alternative return streams. Index funds do not provide equal sector exposure, and investors holding only S&P 500 funds may be exposed to major blind spots, especially if the tech-heavy US market falters or if global commodity cycles become more pronounced.The Power of Return StackingThe discussion explored the concept of “return stacking”—layering alternative investment strategies, such as managed futures or trend-following funds, on top of traditional portfolios without the need to sell core holdings. Traditional diversification often means “diversification by subtraction”; selling some equities or bonds to buy alternatives. However, this approach can feel like a drag in bull markets when those alternatives underperform.Return stacking, however, enables investors to keep their core portfolio intact while adding diversifiers—achieving additive, rather than subtractive, diversification. Even when these strategies lag, the core portfolio continues to deliver, and in times of crisis, the diversifiers can shine. For example, trend-following and managed futures strategies have historically delivered significant positive returns during events such as the 2000 tech crash, the 2008 financial crisis, and the inflation-driven declines of 2021-2022.Embracing Flexibility, Facing UncertaintyEmbracing new strategies, acknowledging the limitations of prediction, and preparing for multiple possible futures isn’t just smart—it’s necessary. The era of relying solely on what’s worked before is over. By recognizing blind spots, embracing innovative methods like return stacking, and acknowledging the behavioral realities of investing, both advisors and investors can build portfolios capable of withstanding whatever the next decade may bring.Mike Philbrick is not affiliated with or endorsed by LPL Financial or Capital Investment Advisers.Securities and Advisory services offered through LPL Financial. A registered investment advisor. Member FINRA & SIPC.The financial professionals associated with LPL Financial may discuss and/or transact business only with residents of the states in which they are properly registered or licensed. No offers may be made or accepted from any resident of any other state. Resources & People MentionedAdaptive Asset Allocation: Dynamic Global Portfolios to Profit in Good Times - and Bad (3)(3) Asset allocation does not ensure a profit or protect against a loss. 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