Classic Investing | Our investment strategy

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 generate returns over the long term while limiting volatility — and to give you better performance than most traditional portfolios. How do we do that? By diversifying: holding more varied geographic exposures than a typical Canadian investor, by investing in a broad basket of fixed-income assets in Canada and the U.S. to provide both safety and additional return, and by holding gold in most portfolios.

The portfolio is based on two basic principles:

Volatility drives return

By and large, the more volatile the asset class, the higher the expected returns. Stocks are typically more volatile than bonds, which are more volatile than cash. Investors, as a group, don’t tend to take risks they won’t be compensated for, so higher-volatility assets offer higher long-term returns to match that bumpier ride along the way. This means that the more the portfolio is weighted toward stocks, the more day-to-day volatility you should expect and the greater the long-term potential for returns should be. 

Taking on too little volatility in your portfolio can actually lower your returns over time, and introduce a real risk of missing out on your long-term goals. 

Diversification improves your odds of achieving attractive returns

There are no guarantees with any investment, and a portfolio with one stock has a range of outcomes wider than an Airbus A380. It may bring huge returns — or huge losses. With a diversified portfolio, however, you’re not betting on a single asset or asset class to determine success or failure. The more varied your investments are, the less likely they’ll perform in the same way — which, perhaps counterintuitively, leads to a narrower range of potential outcomes. Your portfolio’s expected volatility goes down, and the potential for good long-term returns across a variety of market conditions goes up. 

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 majority of volatility in most portfolios — which makes how we diversify those stocks and how we balance our stock portfolio especially important. Here’s how we do it:

We allocate stocks from all over the world. 

Investors tend to prefer investments from their home country, a phenomenon known as the equity home bias. And for good reason: foreign holdings are usually taxed at higher rates than domestic ones, and it can be more comforting to invest in familiar companies. Overly relying on this bias, however, can lead to a portfolio that’s overexposed to the ups and downs of a single economy (or, in the case of some concentrated markets, a single sector). Most portfolios have way too much home bias and would be better off being balanced across several regions. 

Every country or region is bound to underperform at some point. But if your portfolio is geographically diversified, you can also be exposed to a region that beats expectations. An outperforming economy helps smooth out your portfolio’s returns, avoids bad outcomes, and improves compounded returns by minimizing drawdowns. Systematically rebalancing your portfolio between outperforming and underperforming regions — selling winners and buying losers — can also improve your returns. 

Here’s what we mean. 

The chart below shows inflation-adjusted stock market returns of six countries, compared to a portfolio made up of equal parts of all six countries and rebalanced monthly. In the short term, returns in the portfolio are never the highest or lowest. Any one country will outperform the average, like the United States has recently. Over the course of 50 years, however, you’ll see the equally weighted portfolio generates the highest returns (and, compared to Canada alone, about 30% higher).

What does that show? A geographically diversified portfolio helps you end up among the winners over the long term. It can also help you avoid periods of extreme losses. Below is a chart with the worst inflation-adjusted returns of the six countries we mentioned above since 1970. In the vast majority of cases, a geographically diversified portfolio would have significantly reduced losses compared to one focused on a single country.

Our approach to bonds

Many investors simply see bonds as an asset that can dampen the volatility from their stock allocation by providing stability during an economic downturn. However, in a well-constructed portfolio, they can also be a valuable source of returns. 

Government bonds tend to offer low but steady performance, but allocating to a broad basket of bonds — federal and provincial debt, corporate debt, asset-backed securities — can meaningfully contribute to your long-term goals. When economic growth slows, stocks tend to go down, while government bonds actually go up. 

Although stocks are the main driver of return volatility in our portfolio, we try to add a little more volatility (and, therefore, higher returns) in the bonds we select too. By doing this, we diversify your exposure to more environments, which adds more stability in the short term and improves the likelihood of reaching your long-term goals. 

Here’s how we do it:

1. We invest in a broad spectrum of bonds to provide both stability and an added source of return. 

Many participants in the economy sell debt: governments and corporations use bonds to finance long-term spending and growth-seeking projects, respectively, while individuals borrow money to make large purchases like a home. By allocating wisely across all kinds of debtors, you minimize your exposure to any one participant (and potential volatility), and your portfolio will become more efficient as a result. Efficiency means you’ll have higher volatility-adjusted returns, which is to say: more bang for your buck. Many investors see stocks for growth and returns and bonds as a ballast, but a properly constructed bond allocation provides modest returns as well. 

2. We invest in both Canadian and American bonds.

Almost all bonds have a sensitivity to the government borrowing rate (sometimes referred to as the risk-free rate), and this rate is driven largely by the economic conditions of that country. Interest rates in Canada reflect unemployment and inflation in Canada, and similarly, interest rates internationally largely reflect the conditions in those countries. 

While inflation is largely correlated across countries over time, it can diverge, and growth and unemployment conditions can vary a lot. Because of that, it’s prudent to allocate to bonds outside your country to smooth out potential impacts to your portfolio (similar to how we diversify stock allocations). 

We allocate to both Canada and the U.S. to gain this benefit. Global diversification could also provide added benefit, but this comes with increased costs (usually in the form of elevated management expense ratios on the investment vehicles), and, at present, this additional cost erodes the benefit of having it in our portfolio. We constantly monitor our portfolio construction to ensure it aligns with the best asset allocation possible. 

3. We currency-hedge foreign bonds back to the Canadian dollar.

Bonds are typically less volatile than stocks, but holding unhedged international exposure can add volatility to a portfolio without materially boosting returns. If you compare pairs of major currencies — like CAD to USD or CAD to EUR — the value stored in each currency from year to year changes by roughly 6% to 10%. That seems pretty low compared to the stock market’s expected volatility of 15% to 20%, so it can be cheaper to leave international exposure unhedged. 

However, when compared to the lower volatility of bonds, unhedged international exposure can change materially for little benefit. So we hedge our portfolio’s currency exposure when allocating bonds, but not stocks. By avoiding excessive hedging costs, we can maximize long-term returns and the overall efficiency of our portfolios. 

Performance expectations

It all comes back to maximizing your odds of making money in the long run. Making an investment is about trading cash for an uncertain future return. Historically it’s worked out well, but there’s no guarantee of it lasting forever. So we tell our clients to set themselves up for success by staying prepared for whatever might happen. 

We expect these portfolios to provide attractive returns to investors compared to risk-free assets like a savings account. Growth-focused portfolio returns should be roughly the same as long-term stock market performance — about 5% to 6% per year, on top of the Bank of Canada’s interest rate at the time. But again, because we try to narrow your portfolio’s range of outcomes, your returns should be less volatile than an all-domestic stock portfolio. We expect the most conservative portfolios to return 2% to 3% more than a savings account, with only half to two-thirds of the volatility of our growth portfolios. So if long-term cash interest rates are 2% to 3% a year, that means a total expected annual return of 7% to 8% from our growth portfolios and 5% to 6% from our conservative portfolios. 

Keep in mind, these are median return expectations. In any moment in a given year, significant gains or losses are not unusual for any of our portfolios. Investors should expect a wide range of outcomes and prepare accordingly. As we’ve seen above, 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.

Although the strategy has performed about in line with our median expectation, there were clearly large bumps along the way, like when our growth portfolio lost ~20% in March 2020. A loss of 15% or more is well within our range of expectations. Investors should be aware that these large deviations aren’t the most likely outcome, but they do happen. 

In periods where you’re losing money, it’s important to stay invested and focused on the long-term goal of outperforming the interest rates given by a savings account. Time in the market beats timing the market, and ensuring that you remain disciplined is key to long-term success.

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 individual 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.}