Asset allocation is the split of your money between different types of investments, mainly shares and bonds. It is the most important decision in a passive portfolio, more important than which world ETF you choose. Your asset allocation decides how much your portfolio can grow, and how far it can fall in a bad year.
In short
- Shares drive long-term growth; bonds make the ride smoother.
- Choose your split based on your time horizon and how much of a fall you can tolerate.
- European investors usually hold bonds in euros (or hedged to euros) to avoid currency risk.
- Write your target down and stick to it, rebalancing about once a year.
Shares vs bonds in one minute
Shares are ownership in companies. Over long periods they have delivered the highest returns of the main asset classes, but they can fall sharply: a drop of 30% to 50% has happened several times in the last 50 years.
Bonds are loans to governments or companies. They pay interest and usually move much less than shares. High-quality government bonds have often held up or even risen when stock markets crashed, although not always: in 2022 both shares and bonds fell together as interest rates rose.
Mixing the two gives you a portfolio that grows more slowly than 100% shares, but falls less in a crisis. The right mix is the one you can hold through a crash without selling.
How to choose your asset allocation
Ask yourself three questions.
When will you need the money?
Money you need within three to five years should not be in shares at all. For goals ten or more years away, a high share weighting makes sense, because you have time to recover from falls.
How would you react to a big fall?
Imagine your portfolio of €50,000 drops to €30,000 in a few months. If you would sell in panic, your share weighting is too high. Selling at the bottom is the most expensive mistake an investor can make.
Do you have other safe income?
A secure job, a pension or a large emergency fund lets you take more risk in your investment portfolio. If your income is unstable, you may want more bonds.
Example portfolios
These are common starting points, not recommendations. The worst-year figures are rough historical indications for a global portfolio, not forecasts.
| Profile | Shares | Bonds | A bad year could look like |
|---|---|---|---|
| Aggressive | 100% | 0% | −40% to −50% |
| Growth | 80% | 20% | −30% to −40% |
| Balanced | 60% | 40% | −20% to −30% |
| Cautious | 40% | 60% | −10% to −20% |
An old rule of thumb is to hold your age in bonds, so a 30-year-old would hold 30% bonds. Many investors today find that too cautious for a long horizon, but it is a reasonable sanity check.
Which bonds should Europeans hold?
The job of bonds in a portfolio is stability, so keep them simple and in your own currency. A euro investor buying US bonds without currency hedging adds the euro-dollar swings back in, which defeats the purpose.
Two low-cost euro government bond ETFs, for example:
| ETF | ISIN | Annual cost | Dividends |
|---|---|---|---|
| iShares Core € Govt Bond UCITS ETF | IE00B4WXJJ64 | 0.07% | Distributing |
| Vanguard EUR Eurozone Government Bond UCITS ETF | IE00BH04GL39 | 0.07% | Accumulating |
These hold bonds from many eurozone governments with a range of maturities. A global aggregate bond ETF hedged to euros is another common choice. UK investors would use gilt or sterling-hedged funds instead.
Cash in a savings account or a short-term deposit can also play the role of the safe part, especially for money you may need soon.
Putting your asset allocation together
- Choose your split, for example 80% shares and 20% bonds.
- Use one world equity ETF for the shares part, for example from the best all-world ETFs.
- Use one euro government bond ETF for the bonds part.
- Invest monthly and rebalance your portfolio once a year.
- Lower the share weighting gradually as your goal gets closer.
If you prefer an even simpler setup, read about the one-fund portfolio, or the three-fund portfolio for a classic split.
Sources
- Finanzfluss: iShares Core € Govt Bond UCITS ETF
- Finanzfluss: Vanguard EUR Eurozone Government Bond UCITS ETF
- Bogleheads wiki: Asset allocation
- Bogleheads wiki: Simple non-US portfolios
This article is for educational purposes only and is not financial or tax advice. Rules and prices change; check official sources or a qualified adviser before making decisions.