The equity risk premium, a concept in modern financial theory illustrated here, quantifies the premium stocks annually averaged in the 20 years ended September 31, 2022.
Stocks, as measured by the Standard & Poor’s 500, averaged a +9.8% annual return in the last 20 years — more than seven times the +1.2% annual return on the risk-free 90-day U.S Treasury bill in the same 20-year period.
T-bills are considered a riskless investment. That’s because they’re backed by the full faith and credit of the United States Government. In contrast, the value of the S&P 500 index is subject to ups and downs. In theory, if all 500 blue-chip companies in the S&P 500 index were to go bust, your entire investment would be lost. That’s why stocks are considered risky.
Subtracting the return on T-bills from the return on stocks, the resulting +8.7% is the premium paid annually for taking the risk of owning U.S. stocks over the 20 years. To be clear, investing in America’s 500 largest publicly held companies earned an average of +8.7% more annually than a risk-free investment in the past 20 years.
This 20-year period encompassed four bear markets — the tech crash of 2002, the financial crisis of 2008, the COVID downturn of February 5 through March 23, 2020, and the current post-Covid downturn now under way.
Past performance is no guarantee of your future results, and, paradoxically, is precisely why investors were paid a premium for owning stocks.
Stocks are risky investments, and their past performance is not a guarantee of your future results! But if you are investing for retirement or building wealth for children and grandchildren, be glad for it! It is precisely why stocks have returned +8.7% more annually than U.S.-government-guaranteed investments through four bear markets in the past 20 years.
The Standard & Poor’s 500 stock index closed this Friday at 3,639.66. The index lost -2.8% from Thursday and gained +1.5% from last week’s close. The S&P 500 closed Friday up +62.67% from the March 23, 2020, bear market low and down -24.12% from the January 3rd all-time high.
The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market-value weighted index with each stock's weight proportionate to its market value. Index returns do not include fees or expenses. Investing involves risk, including the loss of principal, and past performance is no guarantee of future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance quoted. â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‹
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