Our Insights

About personal finance, investments and markets.
September 4, 2015

How much should you hold in equities?

Getting the asset allocation right is the key decision investors have to make. At its heart, asset allocation is about how much of your assets go into equities and how much goes into bonds. Equities are the core building block to generate above-inflation returns in the long-term while bonds are there to provide stability in your portfolio. But how should investors go about deciding the split between equities and bonds (and yes, those two asset classes are in essence all you need)? Especially when equities are volatile like at the moment, investors want to know how much equities they should really have.

A simple rule of thumb

Your personal risk profile is the key driver here. How much equities you own in your portfolio should be driven by your need, ability and willingness to take risk. A simple rule of thumb can help you narrow down the right asset allocation: your equity exposure should not exceed twice the maximum amount you are willing to lose in any given year. Example: if you don’t want to experience losses in excess of 15% per year, your maximum equity exposure should be 2 x 15% = 30% as equity markets have experienced losses of around 50% in a severe market downturn like in 2008.

It’s all about valuation

Nothing determines long-term performance more than the entry-level valuation. Cheap valuation = high probability of above-average long-term returns and vice versa. Where do we stand today? What is the valuation of equities versus government bonds at the moment? The trailing dividend yield on European stocks – measured by the MSCI Europe index – is currently 2.4% above the yield on a mix of European government bonds, near its all time-highs over the past century. While this has absolutey zero implications for the short term path of equities, it is a powerful reminder of the relative attractiveness of equities versus government bonds.

MS FH

Summary – stick to your plan

While it is perfectly reasonable to be concerned with recent market volatility, you are best served by developing a well-thought-out investment plan that reflects your personal risk profile — and then sticking to it. While this approach can be challenging to maintain during periods of high volatility like right now, the evidence shows that it is the surest path to achieving your financial goals. Remember that we don’t know the future, but we can take actions that affect it.

If you have questions about your investments, we would be glad to discuss with you how we can set-up a financial plan that helps you reach your important goals in life.

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