Equity Risk Premium over Two Centuries, 1825-2017

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
User avatar
Topic Author
SimpleGift
Posts: 3869
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Equity Risk Premium over Two Centuries, 1825-2017

Post by SimpleGift »

“There is nothing riskier than the widespread perception that there is no risk.”
- Howard Marks, Oaktree Capital Management

Since we have fairly high-quality return data for both stocks and bonds going back to 1825 in the United Kingdom, and back to 1871 in the United States, it seems worthwhile to do a post about the historical equity risk premium. Surprisingly, the very long-term equity risk premium over government bonds has been exactly 4.7% in both countries (geometric mean).

But as is so often the case with financial data, this long-term average is misleading. The real story is the variance in the equity risk premium, even over holding periods as long as 20 years. For the U.K., the lowest 20-year ERP was -1.0% and the highest was 14.0% (arithmetic, chart below):
  • Image
    Note: Returns are inflation-adjusted with dividends reinvested.
    Sources: Stock returns various; bond returns Bank of England
For the U.S., the lowest 20-year ERP was 0.6% and the highest was 13.9% (arithmetic, chart below):
  • Image
    Note: Returns are inflation-adjusted with dividends reinvested.
    Sources: Shiller annual data
DISCUSSION: What's striking is, even in two countries dominant in their respective centuries, each relatively unscathed by world war and each with the world's reserve currency, that the premium for investing in stocks has been so variable. Even over 20-year holding periods, investors are not assured of an equity risk premium — and are subject to the luck of the draw.

Thoughts?
golfCaddy
Posts: 728
Joined: Wed Jan 10, 2018 10:02 pm

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by golfCaddy »

Part of this depends on whether you define the ERP as relative to t-bills or cash equivalent or relative to long term government bonds. From the DM data, from 1968-2017, the ERP relative to bills was 4.5% similar to your numbers on a global basis. However, the equity premium relative to long term government bonds was only 0.8%. So over the past 50 years, the term premium has been large and significant, almost as large as the equity premium.
User avatar
Topic Author
SimpleGift
Posts: 3869
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by SimpleGift »

golfCaddy wrote: Sat Jun 30, 2018 12:34 pm So over the past 50 years, the term premium has been large and significant, almost as large as the equity premium.
Yes, the last 50 years have seen high bond returns — but these seem rather unlikly to repeat in the decades ahead. As for the DMS data on the equity risk premium over the entire 20th century (from their Triumph of the Optimists):
Dimson, Marsh & Staunton wrote:We have found that from 1900-2000, the annualized equity risk premium relative to bonds was 5.0% in the United States and 4.4% for the United Kingdom. Across all sixteen countries, the cross-sectional average risk premium relative to bonds was 4.5%, while for the world index it was 4.6%.
But once again, one needs to focus on the variance. While their world index average ERP over bonds in the 20th century was 4.6% CAGR, the standard deviation was 4.8%!
longinvest
Posts: 4538
Joined: Sat Aug 11, 2012 8:44 am

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by longinvest »

SimpleGift wrote: Sat Jun 30, 2018 12:54 pm But once again, one needs to focus on the variance. While their world index average ERP over bonds in the 20th century was 4.6% CAGR, the standard deviation was 4.8%!
According to the Credit Suisse Global Investment Returns Yearbook 2018, Summary Edition, page 37, the equity premium relative to long-term government bonds was 3.2% from 1900 to 2017, and 0.8% from 1968 to 2018 for a world portfolio (23 countries).

That's much lower than 4.8%.
Bogleheads investment philosophy | One-ETF global balanced index portfolio | VPW
longinvest
Posts: 4538
Joined: Sat Aug 11, 2012 8:44 am

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by longinvest »

Astute readers might have noticed that between 1968 and 2018, there were 50 years, yet the average duration of long-term government bonds usually oscillates between 15 and 20 years.
Last edited by longinvest on Sat Jun 30, 2018 1:30 pm, edited 1 time in total.
Bogleheads investment philosophy | One-ETF global balanced index portfolio | VPW
jbranx
Posts: 1544
Joined: Thu Feb 09, 2017 6:57 pm

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by jbranx »

About all I've been able to conclude from reading on the topic is that academics Mehra and Prescott were right to label this "the ERP Puzzle." The fact that the ERP was 19% in the fifties and .3% in the seventies leads me to think it's a combination of risk aversion, inflation, and interest rates. It took until 1958 for stock yields to go lower than bond yields because investors were anchored on the great crash. Benjamin Graham noted that change and advised lower stock holdings, one of his worst market calls. The "nifty fifty" phenom of the sixties drove stock prices up as inflation kicked in, resulting in treasury bills outperforming the S&P 500 from 1968-1981. Graham called that one correctly.

That history, btw, kind of confirms your data that there are long periods of low or negative ERPs. Once the ERP reaches these levels, however, events like Volcker's squashing inflation with super-high interest rates, tend to get the animal spirits moving again. As wonderful as the market rise from '81 to 2000 was, there were many periods over that timeframe when long treasuries purchased in the early eighties had a higher total return than stocks. I recall in the early nineties--four years of no growth in S&P EPS during the Bush term--that Forbes interviewed Bogle and Malkiel with both suggesting that bonds were apt to outperform stocks in that decade. At some points they were right; overall, however, the nineties proved to be a record equity decade.

Didn't Wm. Bernstein suggest somewhere in the "Efficient Frontier.com" that the ERP is approximately the dividend yield? Or have I confused his Gordon Model calculation for future stock returns? Just noticed that the average yield of the S&P from 1936 to yesterday is 3.611%, not too far from the many estimates of ERP. All I can conclude is what you showed in other threads: very long term returns in developed markets have tended to be around 5-6% real. Now, if I only knew if that meant anything for future stock returns!!

Edit: Wm. Bernstein's equity premium calculation was a bit more nuanced than I thought. Here's the key sentences from efficientfrontier.com essay, "The Expected Return One-Step:"

"Now the punch line: the long-term equivalency of interest rates and GDP growth supplies us with a way of estimating the equity premium with breathtaking simplicity. This is because long-term corporate earnings and dividend growth must also be equivalent to GDP growth. And since long-term equity returns are closely approximated by the sum of dividend/earnings growth and the dividend rate, then the equity premium is simply the dividend rate. In other words, since in the long run it is approximately true that:

Treasury yield = GDP growth = Corporate dividend/earnings growth
And that:

Expected equity return = Corporate dividend/earnings growth + Corporate dividend rate
Then, it must be so that:

Stock return – Treasury yield = Equity premium = Corporate dividend rate
(For the purposes of this paper I’ve avoided the term "equity risk premium," as this properly refers to the stock return in excess of the risk-free T-bill rate.)

It’s just that simple. From 1926 to 1994 stocks returned 5% more than Treasury notes—almost exactly the average dividend rate for the period. And going forward, in the very long term, you’re gonna get all of a 1.3% excess return over bonds.

The problem is that on a day-to-day basis you get your return from multiple (PE) change—so-called "speculative" return in Bogle’s terminology. But over the ages your return is dividends plus growth, Bogle’s "fundamental" return. The trick is to think like Samuelson, Sharpe and Bogle, not like the Three Stooges. Is 1.3% an adequate reward for favoring stocks over bonds? You be the judge."
Northern Flicker
Posts: 6877
Joined: Fri Apr 10, 2015 12:29 am

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by Northern Flicker »

golfCaddy wrote: Sat Jun 30, 2018 12:34 pm Part of this depends on whether you define the ERP as relative to t-bills or cash equivalent or relative to long term government bonds. From the DM data, from 1968-2017, the ERP relative to bills was 4.5% similar to your numbers on a global basis. However, the equity premium relative to long term government bonds was only 0.8%. So over the past 50 years, the term premium has been large and significant, almost as large as the equity premium.
I would define the term premium as the additional yield you get beyond the risk-free rate for taking term risk. Rates could have risen or fallen, but they fell. Bond investors were rewarded with the term premium plus the extra bonus from falling rates.
Risk is not a guarantor of return.
User avatar
Topic Author
SimpleGift
Posts: 3869
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by SimpleGift »

Regarding the equity premium today, the latest survey results (paper below) show an expected equity risk premium of 4.4%, with a standard deviation of 3.5%.

The Equity Risk Premium in 2018
Graham & Harvey wrote:We analyze the history of the equity risk premium from surveys of U.S. Chief Financial Officers (CFOs) conducted every quarter from June 2000 to December 2017. The risk premium is the expected 10-year S&P 500 return relative to a 10-year U.S. Treasury bond yield. The average risk premium is 4.42% and is somewhat higher than the average observed over the past 18 years.
To arrive at their average ERP estimate of 4.4%, the survey respondents expect a 6.8% nominal return on stocks, against today's 2.4% nominal yield on 10-year Treasuries. But don't forget their expected 3.5% variance!
jbranx
Posts: 1544
Joined: Thu Feb 09, 2017 6:57 pm

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by jbranx »

SimpleGift wrote: Sat Jun 30, 2018 2:54 pm Regarding the equity premium today, the latest survey results (paper below) show an expected equity risk premium of 4.4%, with a standard deviation of 3.5%.

The Equity Risk Premium in 2018
Graham & Harvey wrote:We analyze the history of the equity risk premium from surveys of U.S. Chief Financial Officers (CFOs) conducted every quarter from June 2000 to December 2017. The risk premium is the expected 10-year S&P 500 return relative to a 10-year U.S. Treasury bond yield. The average risk premium is 4.42% and is somewhat higher than the average observed over the past 18 years.
To arrive at their average ERP estimate of 4.4%, the survey respondents expect a 6.8% nominal return on stocks, against today's 2.4% nominal yield on 10-year Treasuries. But don't forget their expected 3.5% variance!
With the ten-year treasury now at 2.8% and the variance, the ERP calculated here could be as low as .5%! For the cautious and scared, the ten-year at auction or CD's provide the best risk-adjusted return. Using the modified Gordon Model, 1.8% div. yield and 2% GDP growth gets us 3.8%. The standard Gordon, with div. growth rates very high now compared to historical 1.5% or so, results in returns near historical levels. But if GDP growth averages in the 2% range forward, then we face a reversion in the div. growth rate. The conclusions, from formulas anyway, point to probable lower returns for the decade or so ahead, perhaps goosed a bit before the tax-cut benefits fade.

Using the "total investor return" of divs. plus buybacks estimated now at 3.5%, added to 2% GDP growth, we get a respectable 5.5% forward return. Not too shabby.
golfCaddy
Posts: 728
Joined: Wed Jan 10, 2018 10:02 pm

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by golfCaddy »

SimpleGift wrote: Sat Jun 30, 2018 12:54 pm
Dimson, Marsh & Staunton wrote:We have found that from 1900-2000, the annualized equity risk premium relative to bonds was 5.0% in the United States and 4.4% for the United Kingdom. Across all sixteen countries, the cross-sectional average risk premium relative to bonds was 4.5%, while for the world index it was 4.6%.
It's always challenging what to do with data from the first part of the 20th century. The US had a great ERP because it had great equity returns. If you looked at US equity returns from 1900-1960, it's arguably an extreme example of cherry-picking the winner. Other countries had a high ERP because bonds did so terrible, as they experienced periods of hyperinflation in the first half of the 20th century. It's debatable whether the high ERP in the 1900-1968 will ever repeat, if US equity performance reverts to the international mean and central banks in the developed world avoid the high to hyperinflation of earlier times.
User avatar
Topic Author
SimpleGift
Posts: 3869
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by SimpleGift »

golfCaddy wrote: Sat Jun 30, 2018 8:56 pm It's debatable whether the high ERP in the 1900-1968 will ever repeat, if US equity performance reverts to the international mean and central banks in the developed world avoid the high to hyperinflation of earlier times.
Good observations. I agree it's unlikely we'll see out-of-control inflation in the foreseeable future, as central banks around the world learned a hard lesson in the late 1970s and are keen not to repeat those mistakes. Further, global bond markets continue to price 30-year bonds with real yields of less than 1% today — indicating low expectations ahead for future global growth and interest rates.

As for global stock returns: The MSCI World All-Cap Stock Index has an earnings yield of about 5% today (inverse of PE 20). This would put expected ERP in the 4%-4.5% range — just a bit lower than the centuries-long historical average ERP.
User avatar
Topic Author
SimpleGift
Posts: 3869
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by SimpleGift »

Since most investors are in the market for more than 20 years (longer than the OP analysis), this post takes a look at the historical equity risk premium over 30-, 40-, 50- and 60-year investing periods in both the U.K. and U.S.

For the U.K. market since 1825, over 60-year investing periods, the ERP has varied from 2%-8% (red line below) :
  • Image
    Note: Returns are inflation-adjusted with dividends reinvested.
    Sources: Stock returns various; bond returns Bank of England
For the U.S. market since 1871, over 60-year investing periods, the ERP has varied from 4%-8% (in red):
  • Image
    Note: Returns are inflation-adjusted with dividends reinvested.
    Sources: Shiller annual data
Bottom Line: Historically, over an investor's entire 60-year career, the risk of investing in stocks over bonds has generally been rewarded — but the magnitude of these rewards has been quite variable, depending upon the vagaries of fortune.
User avatar
Topic Author
SimpleGift
Posts: 3869
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by SimpleGift »

In the post above we saw that, historically, the longer one's investing career, the lower the variation in the equity risk premium that one realizes over a lifetime. In short: invest early, often, and then "hold on like grim death!" (as the saying goes).

But this data also suggests another way to reduce the variation of the ERP that one realizes over an investing career: cross-country diversification. With our small sample of just two countries, a 50/50 of the mix of the U.K. and the U.S. markets, held over 60-year investing periods, would have improved the variation in one's realized ERP even further (in red, chart below).
  • Image
It seems we've now come to the end of what can be wrung out these long-term, historical data series, I believe — unless Forum members have any specific suggestions for further analysis from them.
GAAP
Posts: 1250
Joined: Fri Apr 08, 2016 12:41 pm

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by GAAP »

SimpleGift wrote: Sun Jul 01, 2018 4:23 pm But this data also suggests another way to reduce the variation of the ERP that one realizes over an investing career: cross-country diversification. With our small sample of just two countries, a 50/50 of the mix of the U.K. and the U.S. markets, held over 60-year investing periods, would have improved the variation in one's realized ERP even further (in red, chart below).
Taken to the logical next step, one would diversify both equity and fixed income across the entire global market -- something that seems remarkably unpopular here for reasons that I still don't understand...
jbranx
Posts: 1544
Joined: Thu Feb 09, 2017 6:57 pm

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by jbranx »

SimpleGift wrote: Sun Jul 01, 2018 4:23 pm In the post above we saw that, historically, the longer one's investing career, the lower the variation in the equity risk premium that one realizes over a lifetime. In short: invest early, often, and then "hold on like grim death!" (as the saying goes).

But this data also suggests another way to reduce the variation of the ERP that one realizes over an investing career: cross-country diversification. With our small sample of just two countries, a 50/50 of the mix of the U.K. and the U.S. markets, held over 60-year investing periods, would have improved the variation in one's realized ERP even further (in red, chart below).
  • Image
It seems we've now come to the end of what can be wrung out these long-term, historical data series, I believe — unless Forum members have any specific suggestions for further analysis from them.
Todd, is a data series available to do charts comparing the ERP over the period, or some part of the period, to the dividend yield? That would test Bernstein's formula that the equity premium is the corporate dividend rate (S&P div. yield, for ex.)
User avatar
siamond
Posts: 5739
Joined: Mon May 28, 2012 5:50 am

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by siamond »

SimpleGift wrote: Sun Jul 01, 2018 4:23 pmIt seems we've now come to the end of what can be wrung out these long-term, historical data series, I believe — unless Forum members have any specific suggestions for further analysis from them.
Actually, if you wouldn't mind sharing (e.g. by PM) the data series (i.e. annual return numbers) you've been using for US/UK stocks & bonds, I'd be curious to assess the 30-years SWRs for each starting year for the various portfolios you've been illustrating on this thread (including the mix US/UK). Then I'll make charts similar to what I used at the end of this blog article (and its follow-ups).
User avatar
Topic Author
SimpleGift
Posts: 3869
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by SimpleGift »

jbranx wrote: Sun Jul 01, 2018 8:24 pm Todd, is a data series available to do charts comparing the ERP over the period, or some part of the period, to the dividend yield? That would test Bernstein's formula that the equity premium is the corporate dividend rate (S&P div. yield, for ex.)
Interesting idea to backtest, thanks. Though total returns are used for the ERP analysis in this thread, I believe that dividend yields are available separately for the entire U.K. data series back to 1825, and certainly for the U.S. series back to 1871. I'll have to go back through the original U.K. data papers and check to make sure.

If dividends are available, when I have time, I'll be glad to run comparisons to ERP over time — and report in a separate thread.
User avatar
Topic Author
SimpleGift
Posts: 3869
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by SimpleGift »

siamond wrote: Sun Jul 01, 2018 10:04 pm
SimpleGift wrote: Sun Jul 01, 2018 4:23 pmIt seems we've now come to the end of what can be wrung out these long-term, historical data series, I believe — unless Forum members have any specific suggestions for further analysis from them.
Actually, if you wouldn't mind sharing (e.g. by PM) the data series (i.e. annual return numbers) you've been using for US/UK stocks & bonds...
Be happy to share the data series. When I have time, I'll try to put it all in a presentable Excel file, and send you a file sharing link.
jbranx
Posts: 1544
Joined: Thu Feb 09, 2017 6:57 pm

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by jbranx »

I wanted to add a big thanks to Todd for his hard work on this thread and all the others he posts. Very good, enlightening work.
columbia
Posts: 3023
Joined: Tue Aug 27, 2013 5:30 am

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by columbia »

SimpleGift wrote: Sat Jun 30, 2018 11:18 pm
golfCaddy wrote: Sat Jun 30, 2018 8:56 pm It's debatable whether the high ERP in the 1900-1968 will ever repeat, if US equity performance reverts to the international mean and central banks in the developed world avoid the high to hyperinflation of earlier times.
Good observations. I agree it's unlikely we'll see out-of-control inflation in the foreseeable future, as central banks around the world learned a hard lesson in the late 1970s and are keen not to repeat those mistakes. Further, global bond markets continue to price 30-year bonds with real yields of less than 1% today — indicating low expectations ahead for future global growth and interest rates.

As for global stock returns: The MSCI World All-Cap Stock Index has an earnings yield of about 5% today (inverse of PE 20). This would put expected ERP in the 4%-4.5% range — just a bit lower than the centuries-long historical average ERP.

Where do you find it having a PE of 20?
Not disputing, just interested in the source.
User avatar
Top99%
Posts: 432
Joined: Sat Apr 22, 2017 9:30 am
Location: Austin, TX

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by Top99% »

jbranx wrote: Mon Jul 02, 2018 1:04 am I wanted to add a big thanks to Todd for his hard work on this thread and all the others he posts. Very good, enlightening work.
+1. I don't have anything to add to this thread but I am learning a lot.
Adapt or perish
User avatar
Topic Author
SimpleGift
Posts: 3869
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by SimpleGift »

columbia wrote: Mon Jul 02, 2018 6:30 am
SimpleGift wrote: Sat Jun 30, 2018 11:18 pm As for global stock returns: The MSCI World All-Cap Stock Index has an earnings yield of about 5% today (inverse of PE 20). This would put expected ERP in the 4%-4.5% range — just a bit lower than the centuries-long historical average ERP.
Where do you find it having a PE of 20?
Not disputing, just interested in the source.
The most recent fact sheet for the MSCI ACWI All-Cap Index is found here.
The P/E ratio is in the Fundamentals section (19.52, as of 5/31/18).

This is the most comprehensive global index that MSCI publishes, I believe — both developed and emerging markets, large caps to micro caps, over 14,000 constituent companies.
User avatar
Rick Ferri
Posts: 9265
Joined: Mon Feb 26, 2007 11:40 am
Location: Georgetown, TX. Twitter: @Rick_Ferri
Contact:

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by Rick Ferri »

Prior to 1950, dividend yield was higher than bond interest. That changed with tax laws the the rise of equity options as executive compensation. Consequently, buybacks are also considered a dividend yield today. Assuming 2% cash dividend and 2% buyback yield, the expected long-term ERP would be about 4%. However, I would make an adjustmehnt for low real interest rates and call it 3%.

Net, net, for planning purposes, I use 3% nominal return for intermediate Treasury bonds and 5% for a total stock market fund. A 50/50 balanced portfolio would be 4%. That number can be pushed 0.5% higher using intermediate corporate bonds, and perhaps 0.5% higher still with an overweight allocation to small-value and emerging market equity.

My two cents.

Rick Ferri
The Education of an Index Investor: born in darkness, finds indexing enlightenment, overcomplicates everything, embraces simplicity.
columbia
Posts: 3023
Joined: Tue Aug 27, 2013 5:30 am

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by columbia »

I can get 4.25% from my TIAA Traditional RC account. If I’m properly understanding the above numbers, the risk of stocks make them seem like a pretty unattractive option for new purchases in my 403b.
jbranx
Posts: 1544
Joined: Thu Feb 09, 2017 6:57 pm

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by jbranx »

columbia wrote: Mon Jul 02, 2018 5:29 pm I can get 4.25% from my TIAA Traditional RC account. If I’m properly understanding the above numbers, the risk of stocks make them seem like a pretty unattractive option for new purchases in my 403b.
Valuation and other fundamental information don't have a sufficiently strong record of predictability for me to take any immediate action, but the low equity premium is certainly grounds for lots of reflection. Here's the latest from Vanguard's economists:

"While inflation is expected to remain low, investors should expect the nominal rate of return on their investments to be in the range of 3% to 5%, compared with historical averages of 9% to 11%, a panel of Vanguard economists said." They say inflation will be close to 2% or so, so real returns might
be an incredibly modest 1-3%.


Here's a link to the transcript:

https://advisors.vanguard.com/iwe/pdf/F ... omain=true
columbia
Posts: 3023
Joined: Tue Aug 27, 2013 5:30 am

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by columbia »

jbranx wrote: Mon Jul 02, 2018 6:23 pm
columbia wrote: Mon Jul 02, 2018 5:29 pm I can get 4.25% from my TIAA Traditional RC account. If I’m properly understanding the above numbers, the risk of stocks make them seem like a pretty unattractive option for new purchases in my 403b.
Valuation and other fundamental information don't have a sufficiently strong record of predictability for me to take any immediate action, but the low equity premium is certainly grounds for lots of reflection. Here's the latest from Vanguard's economists:

"While inflation is expected to remain low, investors should expect the nominal rate of return on their investments to be in the range of 3% to 5%, compared with historical averages of 9% to 11%, a panel of Vanguard economists said." They say inflation will be close to 2% or so, so real returns might
be an incredibly modest 1-3%.


Here's a link to the transcript:

https://advisors.vanguard.com/iwe/pdf/F ... omain=true
Using it as a proxy for the market, SP500 has returned 5.8% in 2018. Given that I can utilize the above TIAA fund, the risk premium for me has been 1.55%. That seems...low.

In the abstract, what would you consider the minimum acceptable risk premium?
JBTX
Posts: 7370
Joined: Wed Jul 26, 2017 12:46 pm

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by JBTX »

SimpleGift wrote: Sat Jun 30, 2018 2:54 pm Regarding the equity premium today, the latest survey results (paper below) show an expected equity risk premium of 4.4%, with a standard deviation of 3.5%.

The Equity Risk Premium in 2018
Graham & Harvey wrote:We analyze the history of the equity risk premium from surveys of U.S. Chief Financial Officers (CFOs) conducted every quarter from June 2000 to December 2017. The risk premium is the expected 10-year S&P 500 return relative to a 10-year U.S. Treasury bond yield. The average risk premium is 4.42% and is somewhat higher than the average observed over the past 18 years.
To arrive at their average ERP estimate of 4.4%, the survey respondents expect a 6.8% nominal return on stocks, against today's 2.4% nominal yield on 10-year Treasuries. But don't forget their expected 3.5% variance!
I had Harvey as a professor at grad school. I'm not sure but I may have been in one of the first classes he taught.

Not that it is at all useful to this thread.
jbranx
Posts: 1544
Joined: Thu Feb 09, 2017 6:57 pm

Re: Equity Risk Premium over Two Centuries, 1825-2017

Post by jbranx »

columbia wrote: Sun Jul 22, 2018 7:49 pm
jbranx wrote: Mon Jul 02, 2018 6:23 pm
columbia wrote: Mon Jul 02, 2018 5:29 pm I can get 4.25% from my TIAA Traditional RC account. If I’m properly understanding the above numbers, the risk of stocks make them seem like a pretty unattractive option for new purchases in my 403b.
Valuation and other fundamental information don't have a sufficiently strong record of predictability for me to take any immediate action, but the low equity premium is certainly grounds for lots of reflection. Here's the latest from Vanguard's economists:

"While inflation is expected to remain low, investors should expect the nominal rate of return on their investments to be in the range of 3% to 5%, compared with historical averages of 9% to 11%, a panel of Vanguard economists said." They say inflation will be close to 2% or so, so real returns might
be an incredibly modest 1-3%.


Here's a link to the transcript:

https://advisors.vanguard.com/iwe/pdf/F ... omain=true
Using it as a proxy for the market, SP500 has returned 5.8% in 2018. Given that I can utilize the above TIAA fund, the risk premium for me has been 1.55%. That seems...low.

In the abstract, what would you consider the minimum acceptable risk premium?
I'd be inclined to raise my equity allocation if the ERP was close to the historical 4.4% but Vanguard economists may be closer to the mark than the CFO's who, after all, also help set the expected return on their pension plans and have an interest in a higher estimate of returns. With plenty of preferred stocks available at 5.5% and higher currently, I'm picking up some of those with good call protection. Just bought a 4% 30-year, callable CD in my IRA, figuring if rates stay low it will be called; otherwise my heirs will have an insured product yielding about as much as the ERP offers.
Post Reply