Question

While the evidence suggests that over long periods of time that stocks will outperform bonds, individuals with a long-term investment horizon may still choose to invest in bonds. Is this rational behavior? Why or why not? Give real world example

Answer 1

Individual with the long-term horizon may still be choosing to invest into bonds because-

A. these individuals are mostly risk-averse individual and they will not be liking the volatility in the stocks

B.these individuals will be trying to diversify their portfolio and they will be having an appropriate representation into stocks

C. these individual will also want uniform income in the form of interest payment so they will be inclined towards debt.

D. Volatility Is not liked by risk-averse investors and volatility means higher systematic risk so they will be trying to avoid the volatility in the market and they will be trying to expose themselves to the bonds.

This is a rational behaviour because investors are often trying to take low risk bets when they feel like they do not have adequate risk appetite and hence they will not be diversifying themselves into the stocks and they will be taking appropriate exposure is into the bonds only because they want uniform income low liquidity and certainty of repayment of the capital.

To give an example at the time of the global recession in 2008,there was a large investment of various investors into bonds as they were highly fearful of the stock and they invested into bonds and even at the times of the coronavirus crisis these investors are exposing themselves to risk-free treasury securities.