What is risk and how does Wealthsimple judge it?

So you've created an account with Wealthsimple and now you're wondering if we've put you in the right portfolio. In fact, how does a risk assessment questionnaire or a financial professional decide what risk profile is best suited for you? Read on to understand Wealthsimple's investment strategy, how stock markets generally move, what risk really means, and how we assess your risk profile.

Understanding Passive Investing

Wealthsimple uses a passive investment strategy - you can read more about it here - which basically means that your portfolio will track the performance of the global market. It's also important to understand that, historically, stock markets have almost always trended upwards given a long enough period of time. However, they don't go up in a straight line - sometimes they go up, sometimes they go down. Some years they go up a lot, some years they go down a lot, and some years are fairly flat. In other words, stock markets fluctuate constantly but trend upwards.

Wealthsimple will ensure that your portfolio is tracking the global market movements and our goal is to capture the long term growth trend. 

So what does risk really mean?

Now that you understand the basics of how markets generally move, let's dig into what risk actually means. Since nobody can control market movements (or returns for that matter), Wealthsimple focuses on controlling the level of risk you should expose yourself to. Risk (or Volatility as we call it in the financial industry) is simply a measure of how much your investments will fluctuate depending on how markets move. If you take on more risk and markets rise, you're likely to have higher gains. But if you take on more risk and markets fall, you're likely to have larger losses. In other words, taking more risk will make your account more volatile. If you take on lower levels of risk, your investments will gain less or lose less if markets rise or fall, respectively. So taking lower risks leads to less volatility, or more stability.

In general, controlling risk is done through asset allocation, which is a fancy term that simply refers to how much of your money is in stocks (i.e. equities) versus how much is in bonds (i.e. fixed income). Stocks (or shares in companies) have historically generated greater returns over the long term than bonds but have also been the main contributor of higher fluctuations. On the other hand, fixed income securities or bonds provide a steady (although lower) source of interest income.  They experience much smaller fluctuations than equities. 

To put it simply, having more equities in your portfolio leads to higher risk (or fluctuations) but better long-term growth potential. Having more bonds or fixed income in your portfolio provides better short-term stability but reduces the long-term growth potential of your portfolio. 

How does Wealthsimple assess my risk?

Using a combination of your objectives, your investment time horizon, your level of income, your net worth, your investment knowledge, your past investment experience, and your personal tolerance to risk, Wealthsimple is able to assess how much risk (or potential fluctuations) your investments should be subject to.

Now for the million dollar question:

When should you be in a conservative portfolio?

When should you be in a balanced portfolio?

When should you be in a growth portfolio?