We think it’s important for our clients to know not just what is in their portfolios, but why it’s there. In this guide, we’ll walk you through how we invest, why we choose the assets we do, and what you can expect from your investments in different market conditions. We tried to be as comprehensive as possible, but if we missed anything and left you with questions, just ask. 

The super-short version: Wealthsimple’s Classic portfolios offer broad market exposure that’s designed to optimize returns while limiting risk — and give you better performance than most traditional portfolios, especially during downturns. How do we do that? By diversifying: holding more varied geographic exposures, focusing on lower volatility stocks (which tend to have equal or better returns than high-risk stocks), and by investing in riskier government bonds and gold.

Want more detail? Read on.

The portfolio is based on two basic principles:

Risk Drives Return
By and large, the riskier the asset class, the higher the possible returns. As a group, stocks are typically riskier than bonds, which are riskier than cash — and generally they offer higher long-term returns to match that risk. This means that the more the portfolio is weighted toward stocks, the riskier it tends to be and the greater the long-term potential for returns should be. 

Diversification Improves your Odds of Achieving Attractive Returns
There are no guarantees with any investment, just a range of potential outcomes. A portfolio with only one stock has a range of outcomes wider than an Airbus 380. It may bring huge returns, but it also may bring huge losses. With a diversified portfolio, however, you’re no longer betting on a single asset or asset class to determine success or failure. The more varied investments are, the less likely it is they will perform in the same way, which leads to a narrower range of potential outcomes. Your risk decreases while the potential for long-term returns across a variety of market conditions increases.

Our Principles in Action

Here’s how all that stuff above influences the assets we choose for our core portfolio.

Our Approach to Stocks

Stocks drive the risk in our portfolio — which makes how we diversify those stocks and how we balance the risk of our stock portfolio especially important. 

1. We invest in stocks from across the world

Investors tend to have a bias toward wherever they’re from. It’s called the equity home bias, and it exists because foreign holdings tend to be taxed at higher rates — and because there’s comfort in investing in companies you’re familiar with. While there is merit to those arguments, most portfolios have way too much home bias and would be better off being balanced across multiple geographies.

At one time or another, every country or region is bound to underperform. But if you’re diversified geographically you’re often also exposed to a region that exceeds expectations. This helps you smooth out returns, avoid bad outcomes, and improve compounded returns. In addition, systematically rebalancing between outperforming and underperforming regions means you are selling winners and buying losers, which can improve returns..

This chart shows inflation-adjusted stock market returns of six countries compared to a portfolio consisting of the stocks of each country, weighted equally (effectively allocating 1/6 of the portfolio to each country and rebalancing between them monthly). In the shorter term, returns in the portfolio are never the highest or the lowest as any specific country is guaranteed to outperform the average, like the United States has recently. Over the course of 50 years, however, an equally-weighted portfolio generates the highest returns. 

Source: Bloomberg. This chart takes the total country returns, by month, since 1971 through February 2023, and deflates them by Canada CPI to generate real returns. All returns in CAD. This analysis is for illustrative purposes only to show the benefits of diversification, and does not consider fees, taxes, or any other implementation costs. Past performance does not guarantee future results, which may vary.

While being diversified geographically means you will end up among the winners over the long term, it also may help you avoid periods of extreme losses. Below, we show the worst inflation-adjusted returns of each country since 1970 over 5 and 10 year periods. In the vast majority of cases, being diversified across countries would have reduced losses significantly.

Source: Bloomberg. This chart takes the total country returns, by month, since 1971 through February 2023, and deflates them by Canada CPI to generate real returns. All returns in CAD. This analysis is for illustrative purposes only to show the benefits of diversification, and does not consider fees, taxes, or any other implementation costs. Past performance does not guarantee future results, which may vary. Inspiration for this analysis comes from Asness, “Seven Thoughts about Running Big Money for the Long-Term”, 2009.

2. We invest in less risky stocks

You might think higher-volatility stocks would provide higher returns, but in reality that tends to work at the asset class level, and not for individual stocks. Historically, lower-volatility stocks have actually provided similar or even slightly better returns than their high-volatility counterparts. One theory to explain this is that investors tend to overpay for high-risk assets with the potential for lottery-like returns.

You can see this phenomenon in action in the charts below, which show the returns of stocks sorted by their volatility. Note that the lower volatility stocks have among the highest returns, and the stocks with the highest volatility have the lowest. By focusing on lower-volatility stocks, we can reduce the portfolio’s risk without reducing long-term return expectations.

This analysis is for illustrative purposes only to show the linkage between volatility and returns, and does not consider fees, taxes, or any other implementation costs. Returns are for Russell 1000 (1979-2021), MSCI World (1995-2021), MSCI Emerging Markets (1998-2021). Past performance does not guarantee future results, which may vary.

This approach gives us a particularly useful advantage: historically, while indexes like ours that are weighted to minimize volatility have underperformed their market-cap-weighted peers during major rallies and bull markets, they have outperformed them during market downturns. Imagine you have two stocks with similar average annual returns, but one is much more volatile. In a bear market, the less volatile stock is likely to lose less — and that can help compounded returns significantly. 

Our Approach to Bonds

Bonds are traditionally among the least risky assets in a portfolio. As a result, they tend to offer low-but-steady performance, with lower potential for damaging downturns. When economic growth slows, stocks tend to go down as well, while government bonds tend to increase in value.

Although stocks are the drivers of risk in our portfolio, we try to add a little more risk in the bonds we select, too. This helps diversify the portfolios’ exposure to more economic environments, which adds even more diversification. Here’s how we do it:

1. We invest in more government bonds — and fewer corporate bonds.

The bonds that companies issue tend to perform similarly to their stocks. And since we already are invested heavily in stocks, putting money in those corporate bonds would lead to less diversification for our portfolios. It would also compound the risk of the portfolio performing poorly during recessions. With government bonds, we can add more fixed income risk to our portfolio without adding to equity risk during inevitable market downturns.

2. We invest in more longer-duration government bonds.

Bonds that take longer to mature are riskier than shorter-duration bonds, which makes them appealing to us, since they can often provide higher returns when stocks are down, particularly when stocks lose money for an extended period of time, which can happen from time to time. Asset class diversification helps us avoid lost decades where stocks return very little. Below, we show the returns of long-term Canadian bonds, gold, and world stocks, since 2002, but divided by decade.

Source: Bloomberg. This chart illustrates  the total returns of long-term Canadian bonds, gold, and world stocks in Canadian dollars for the time period indicated.  It does not consider fees, taxes, or any other implementation costs.  Past performance does not guarantee future results, which may vary.

Performance expectations

It all comes back to maximizing your odds of making money in the long run. Making an investment is trading cash for an uncertain future return. Historically, that’s been a good trade, but there’s no guarantee. So we tell our clients to set themselves up for success (having enough to spend on the things they want when they want them) and stay prepared for whatever might happen.

We expect these portfolios to provide attractive returns relative to risk-free assets, like a savings account. For growth-focused portfolios, that should mean earning roughly the same amount as the long term returns of the stock market — which has been about 4-5% per year on top of the Bank of Canada interest rate. But again, because we try to narrow your range of outcomes, that return should come with less volatility than an all-stock portfolio. For the most conservative portfolios, we expect about 2% more than you’d get with a savings account and only ½ to ⅔ of the volatility of our growth portfolios. Assuming long-term cash rates of 2-3%, that means a total expected annual return of 6-7% from our growth portfolios and 4-5% from our conservative portfolios. (This is a significant increase from recent years due to the recent increase in interest rates.)

Again, these are just median return expectations, and investors should expect a wide range of outcomes.  In any moment in a given year, significant gains or losses are not unusual for any of our portfolios. As we’ve seen above in the chart about equity performance, stocks are an excellent bet to outperform inflation over longer time periods. Over shorter time periods, however, there is no guarantee of making money; the chart below shows the performance of our growth portfolio since inception compared to our expected range of outcomes for the portfolio. 

Returns shown net of fees  from August 2014 - March 2023 and are simulated based on Wealthsimple’s growth portfolio asset allocation through time. Range of returns is from a block bootstrapped simulation based on a backtest of the current asset allocation to 1993. Past performance does not guarantee future results, which may vary.

Although the strategy has performed about in line with our median expectation, there were clearly large bumps along the way, like when the portfolio lost ~20% in March 2020. There will be years where our growth portfolio loses 15% or more. That is well within our range of expectations; you can see that a bottom decile outcome is actually a several-year long period where the portfolio has negative returns. Although that’s not the most likely outcome, it is possible, and during periods where you’re losing money, it’s important to stay invested and focused on the long-run goal of outperforming cash.

The Big Takeaway

You may be sick of hearing us say this, but we’ll do it one more time: We believe that a highly reliable way to achieve your financial goals is by investing in low-cost, diversified portfolios of risky assets — and staying invested in them for the long term. Our goal is to set you up for reliable returns across a range of market conditions — not just the good ones.

Wealthsimple Inc. is registered as a Portfolio Manager in every Canadian jurisdiction.

All charts shown are for illustrative purposes only and do not reflect the returns of an actual account. Indicated performance data are historical or simulated for the period indicated. Rates of return do not take into account any tax payable. Past performance is not indicative of future results and future performance may materially differ from expectations.