Question

Over long periods, stock investments have tended to substantially outperform bond investments. However, it is not at all uncommon to observe investors with long horizons holding their investments entirely in bonds. Are such investors irrational? Why or Why not? Illustrate with real-life examples.

Answer 1

Ans:- No it is not true that those who invest in bonds they are irrational investors. Every investor has different risk-taking abilities. Yes over a long period of time stock investments have the tendency to outperform bond investments but it also true that stock investment or equity investment are riskier investments than bonds. There is a possibility that the company may go bankrupt or its stock price may fall heavily due to its internal or external factors and the equity investors may end up in heavy loss.

On the other hand, government bonds or any other types of bonds are more secure investment than the equity investment because they give fixed income for a long period of time with minimum risk. Also in the case of default bondholder may get more preference as compared to stockholders or equity holders. Therefore the investors who prefer to invest in bond for a long-time period they are not inclined towards riskier investment but that does not mean they are irrational investors.

For example. In the financial crisis 2008 when companies fall down in the U.S the equity investors all around the globe suffered heavy losses but those investors who have invested in U.S government bonds or any other type of long term bonds might not have suffered that type of loss which equity investors suffered.

Investment works on one thumb rule the more risk you take the more return you will get the less risk you take the less return you will get.