Equity Risk Premium Grew Wider And More Important
Published Tuesday, February 23, 2021 at: 10:09 PM EST
Modern portfolio theory holds that investors get paid extra return for taking risk. The concept is simple, but can be hard to implement without coaching and education, and it grew more important lately: Investors who take equity risk expect to earn extra return.
To quantify the risk premium of stocks, the amount you get paid for owning a risky asset, according to modern investment theory, here are the numbers: Over the 23 years ended on December 31, 2020, the risk-free 90-day U.S. Treasury bill averaged an annual return of 1.86%, compared to the 8.08% annualized return on the Standard & Poor’s (S&P 500) stock index. By subtracting the 1.86% return on the no-risk asset from the 8.08%, the resulting 6.22% annually earned on stocks over the boom-and-bust cycles since 1998 represents the equity risk premium.
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