What Equity Allocation Should a Portfolio Have?

The equity allocation describes what proportion of a portfolio is invested directly or indirectly in equities. Direct investment can take place through individual stocks, while indirect investment can take place through ETFs, funds or Multi Asset funds with an equity component. A high equity allocation means that equity markets have a stronger influence on the portfolio. A lower equity allocation limits this influence.

This also points to the basic relationship between risk and return potential. Investors who take on more equity risk accept stronger fluctuations in value. In return, higher long-term return opportunities can arise, because investors expect appropriate compensation for bearing uncertainty. This return opportunity is not guaranteed, however. It is the reason why the equity allocation needs to be managed deliberately in the first place.

It does not follow, however, that there is one mathematically correct equity allocation for everyone. A portfolio does not become appropriate simply because a particular number sounds well balanced. An allocation of 30% may be too high in one case, too low in another and simply irrelevant in a third.

The search for the optimal equity allocation can therefore quickly become misleading. It suggests that the solution lies in the percentage itself. In reality, the equity allocation is only the expression of a prior decision: how much market risk may the portfolio bear without jeopardising the investment purpose?

Simple age-based rules also fall short when used in isolation. Age can provide an indication of the investment horizon, but it cannot replace an analysis of the specific objective. A young person may need the money in three years. An older person, by contrast, may have capital that is intended to remain invested for a long time.

The better question is therefore not: which equity allocation is right? A more useful question is: which equity allocation fits the investment objective, the investment horizon and the available risk buffer? The investment objective clarifies what the money is being invested for. The investment horizon follows from this and shows how long the money can remain invested. The risk buffer indicates how much fluctuation in value can be tolerated without jeopardising the purpose of the investment.

The investment objective is the starting point for any sensible equity allocation. Money invested for long-term wealth accumulation or as an additional pillar of retirement provision serves a different purpose from capital that will soon be needed for a specific obligation.

A clear example is provision for a very young child. If a child is four years old and assets are to be built up for their later retirement, a very long investment horizon is likely. In Germany, this period can roughly span several decades. In such a case, an equity-oriented risk profile can be plausible at the beginning, because the capital will not be needed for a long time.

Over a long period, the compounding effect can play a special role. This means that not only the capital originally invested can work, but also returns already generated can be reinvested. The longer an investment process runs, the more important it becomes not to cut off return opportunities too early.

However, this does not mean that high equity allocations are automatically right. The decisive point is the link between the investment horizon and the ability to withstand interim fluctuations in value. Anyone who will not rely on the capital for a long time is more able to bear such fluctuations than someone who will soon need access to a specific amount.

For this reason, the tolerable fluctuation in value at the beginning of a very long investment process may be higher than later on. The closer the point comes at which the capital is meant to fulfil a specific function, the more the question changes. Over time, a long-term growth task can become a task of preservation and withdrawal.

The equity allocation should therefore not only match today’s age, but also the purpose of the assets. With a very long investment horizon, a high equity orientation can be understandable. However, it remains a deliberate risk decision and not a general rule.

The situation is different if the capital is needed in a few years for a specific obligation. Someone who wants to repay a loan in three years faces a different problem from someone who is building wealth over decades. In this case, the focus is not on maximising participation in equity markets, but on whether the required amount will be reliably available when needed.

In this situation, the risk buffer becomes decisive. It describes how much fluctuation in value the portfolio could withstand without putting the objective at risk. With a buffer of 10% or 15%, a more conservative profile may be more appropriate than with significantly greater flexibility.

A larger risk buffer can open up more flexibility. However, it does not create a general recommendation for a particular equity allocation. It only means that more fluctuation may be tolerable than with a narrow buffer. The overriding question remains how much risk should be imposed on the specific investment objective overall. Only from this can it be derived whether a higher equity allocation can sensibly be examined or whether a more conservative profile is more appropriate.

With a very short investment horizon, pure equity portfolios are generally not suitable. This does not mean that equities must necessarily be excluded completely. The decisive factor is the dosage. The question is therefore not only "equities yes or no", but how much equity risk the specific objective can tolerate.

Especially over short periods, average figures for equity market crashes can be misleading. An average crash duration of one year or one and a half years is of little help if one’s own capital requirement falls precisely into a longer weak phase. Anyone who has to repay a loan cannot rely on the market returning to its previous level in time.

Historical extreme phases show why this caution is important. After the dotcom bubble burst in the early 2000s, it took many years for certain technology-heavy indices to reach their previous highs again. The Nasdaq Composite did not reach record highs from the dotcom era again until 2015.

In such situations, a portfolio can still be significantly in negative territory even though long-term average statements may sound reassuring.

Japan also provides a striking example of how long recovery phases can last. The Japanese benchmark index Nikkei 225 reached a record level at the end of December 1989, at the peak of the asset price bubble at the time. It was not until February 2024 that the index exceeded that level again.

Between the high at that time and the later exceedance of that level, around 34 years passed. For investors who would have needed their capital earlier during this period, such a time span would hardly have been explainable by an average crash duration.

Examples of this kind are not an argument against equities as an asset class. Rather, they show why equity risk should be deliberately dosed. What matters is not only whether equities offer long-term return opportunities, but whether the portfolio also fits the investment objective if a recovery takes longer than expected.

A high equity allocation does not mean that other principles of portfolio management become unimportant. Diversification remains especially central. It is considered one of the few advantages investors can use in the market without having to make an additional market forecast.

The reason is simple: anyone who spreads capital across many companies, regions and markets is less dependent on the success of individual positions. This can reduce the fluctuations of a portfolio for comparable return opportunities.

An example makes this clear. Anyone who invests in only a few stocks bears not only general equity market risk, but also the additional risk that precisely these companies disappoint. If the capital is spread more broadly, a single negative development carries less weight. The added value of diversification therefore does not lie in avoiding risks completely. It lies in reducing unnecessary individual risks without automatically having to give up the return opportunities of the equity market.

Diversification is often understood as broad spreading. In practice, however, it is not enough simply to buy several ETFs or funds and automatically conclude that the portfolio is sufficiently diversified. Different products can have similar focuses and overlap more strongly than may be apparent at first glance.

Investors should therefore examine what their ETFs or funds are actually invested in. What matters is not only the product name, but the actual allocation. If several funds contain very similar stocks, regions or sectors, the perceived diversification can be greater than the actual diversification.

This point applies regardless of age. A long-term portfolio for a child should be checked for overlaps just as much as a portfolio shortly before retirement. Even an equity-oriented approach should not mean abandoning diversification principles.

This is particularly important when considering the equity allocation. Two portfolios can both have a high equity allocation and still carry very different risks. One may be broadly diversified across markets, while the other may depend heavily on only a few segments. The percentage alone therefore does not say enough about portfolio risk.

The equity allocation should therefore always be considered together with the internal structure of the portfolio. Only the combination of allocation, diversification, product overlaps and investment objective provides a picture of whether the portfolio fits its intended purpose.

The appropriate equity allocation does not necessarily remain constant throughout life. As an important objective approaches, it can make sense to reduce higher-risk asset classes gradually. This idea is often associated with lifecycle investing.

Returning to the example of a child building wealth over many decades for later retirement, a high equity orientation may be plausible at the beginning. However, if this additional pillar is later meant to play a significant role in retirement provision, the starting point changes over time. Ten years before retirement, the risk of an unfavourable market decline needs to be assessed very differently than many decades earlier.

In such a phase, a more balanced profile may come into focus. One possibility might be, for example, an equity allocation of 50% or 60% within a balanced Multi Asset fund or across several balanced Multi Asset funds. Here too, the decisive point is not the number as a general recommendation, but the change in risk needs before the target date.

The closer retirement comes, the more reducing risk can move into the foreground. The objective is not to eliminate return opportunities altogether. The aim is to reduce dependence on the short-term level of the equity market when the capital will soon need to fulfil an important function.

At the same time, the return engine should not be switched off completely. Even during retirement or in a withdrawal plan, it can make sense to remain open to return opportunities. Otherwise, another risk arises: the purchasing power of the assets can gradually decline due to inflation.

This shows the other side of an overly defensive allocation. Anyone who focuses only on avoiding fluctuations can underestimate the erosion of purchasing power. Especially if capital is meant to last for many years in retirement, the equity allocation should therefore not be viewed solely through the lens of short-term security.

Lifecycle investing therefore does not mean reducing equities mechanically according to age. It means regularly adjusting the relationship between return opportunities and risks to the purpose of the capital. The more important a specific amount becomes at a specific point in time, the more precisely it must be examined how much fluctuation the investment objective can still tolerate.

The appropriate equity allocation cannot be derived universally from a formula. The starting point is always the purpose of the money. Only from this does it follow how long the money can remain invested and how much fluctuation in value the investment objective can tolerate.

A very long investment horizon can make a high equity allocation plausible at the beginning, especially when long-term wealth accumulation or retirement provision is the focus. A short investment horizon, for example three years until a loan repayment, requires a much more cautious assessment. Pure equity portfolios are generally not appropriate in such cases, even though equities do not necessarily have to be excluded in a dosed form.

The most important insight is this: the equity allocation is not an isolated value. It is part of portfolio management that brings together the investment objective, investment horizon, tolerable fluctuation in value, diversification and inflation risk. Anyone who simply looks for a number misses the core of the decision. Anyone who first clarifies the purpose of the capital comes much closer to the appropriate equity allocation.