Question

Over long period of time, share investments tend to substantially outperform bond investments. However, it is not unusual to observe investors with long horizons holding entirely bonds. Are such investors irrational? Please explain.

Answer 1

No they are not irrational necessarily. Investors have different risk handling capabilities. Some people are very risk averse and thus, dont need high returns if risk is high. Stocks are riskier than bonds and their volatility is higher than bonds. There is a risk return tradeoff and such investors would not like to take too much risk and would be happy even with relatively smaller expected return of bonds over stocks.

Remember stocks are riskier than bonds and typically have higher expected returns than bonds. But if an investor is highly risk averse, bonds can be more attractive given less risk and his/her portfolio can be entirely made of bonds.