Equities.
This. It's not that equities will do worse over the long run... obviously, it's to the contrary. It's just that there's a greater variation in their returns. If you're willing to wait and buy a house a bit later if the market's down (which most people are), then there's no reason not to keep it in stocks. It's only if you know that you need to buy "in 2014, no matter what the economy does, end of story" that you need to be looking at stability.
Absolutely. Too many people, IMO, think that it's going to be a fixed time frame, so they don't want to "risk" it.. nor get the potential gains. So down market, you add 6 months to your 5 year plan to buy a house. No big deal. The more likely scenario, IMO, is you make more than you would have otherwise and can buy a house even earlier, if you want!
In any case, you're spot on that if your time frame is flexible, it's often worth investing in slightly riskier assets, IMO.
YMMV based on personal risk tolerance preferences.