Blog - Investing Notes
April
14, 2005 – The Best Benchmarkers, Ever!
In their April 2005 draft of "History and the Equity Risk Premium", two pioneers in the
definition and measurement of the equity risk premium, William Goetzmann and Roger
Ibbotson, recount the history of this essential benchmark for stock investment returns.
Then, they update their estimate of its value for U.S. equities over the past two
centuries. Their conclusions are:
- For the period 1792 through 1925, the arithmetic (geometric)
equity risk premium, as measured by the spread over government bonds, is about
3.8% (2.7%). The arithmetic real return for stocks is about 7%. Because government
bonds were arguably not riskless during this early period in U.S. history, the
actual equity risk premium likely lies between 3.8% and 7%. (See Table I below.)
- For the period 1926 through 2004, the arithmetic (geometric)
equity risk premium, based on the spread over government bonds, is about 6.6%
(5.0%). The arithmetic real return for stocks is about 9.3%. (See Table II below.)
- America’s political and economic success in the 20th Century
suggest that there might be "survival bias" in these results - that the U.S.
experience may not be the best baseline for projecting the future. However,
maybe it is for those who plan to invest in U.S. stocks. Exceptional performance
may be be a reliable result of the American configuration of laws, political
system, cultural mixture and practical orientation.
In summary, stocks have significantly outperformed less risky
asset classes in the U.S. for over 200 years. Volatility comes with the outperformance.
Read the whole thing. There are no formulas.
For other research on the equity risk premium, see Blog
Synthesis: The Equity Risk Premium.
