Final answer:
A risk-averse person might prefer bonds over stocks due to their low volatility; however, excluding stocks entirely from a portfolio is not advisable. Diversification is crucial, allowing for a mix of assets that balances risk and potential returns, especially over the long term. The optimal portfolio depends on various factors including the investor's age, goals, and time horizon.
Step-by-step explanation:
Should a Risk-Averse Person Hold a Portfolio with No Stocks?
When considering an investment portfolio for a risk-averse individual, the focus is on managing the tradeoff between expected return and risk. Generally, individuals who are risk-averse prefer investments that have lower volatility, such as bonds, which offer more stable returns compared to stocks. Stocks are associated with higher potential returns but are also riskier, as evidenced by the fluctuation in stock values like the S&P 500's 37% decline in 2008 followed by a 26% increase in 2009. On the other hand, the value of bonds largely depends on interest rate fluctuations and is typically less volatile than stocks, making them more suitable for risk-averse investors.
However, holding a portfolio consisting exclusively of bonds is not necessarily the optimal approach for risk-averse investors. Diversification is a key investment strategy that mitigates risk by spreading investments across various asset classes, including stocks and bonds from a wide range of companies. By diversifying, investors can reduce the impact of negative performances from any single asset or company. This does not mean avoiding stocks altogether but rather including a careful selection of stocks to balance the portfolio.
Ultimately, while risk-averse investors may tend toward bond-heavy portfolios, excluding stocks completely overlooks the benefits of diversification and the higher long-term returns that a balanced mix of assets could provide. The decision on asset allocation should also take into consideration factors such as the investor's age, investment goals, and time horizon. Younger investors, for instance, might allocate more to stocks, given their longer time horizon to ride out market volatility and capitalize on the higher returns that stocks can offer over an extended period.