Risk Premium

The risk premium is the extra reward for investing in higher-volatility assets. Find out if your portfolio is capturing it and analyse it with Index Balance.

Definition

The risk premium is the additional return that an investor demands for taking on a level of risk above that of a risk-free asset, typically short-term government bonds. If US Treasury bills yield 4% and global equities have historically returned 10%, the equity risk premium would be approximately 6%.

For the index fund investor, the equity risk premium is the fundamental reason why it is worth tolerating stock market volatility over the long term. Without that premium, there would be no point in investing in equities instead of bonds or deposits. The historical evidence shows that this premium has been persistent over more than 100 years and in almost all developed markets, although it is not guaranteed for the future.

Index Balance lets you compare your portfolio's return against a reference asset and visualise whether the risk you are taking is translating into additional return. Try it free at indexbalance.com.

Practical example

Between 1900 and 2023, German short-term government bonds returned approximately 3% per year on average. The German equity market returned around 8.5% per year. The historical risk premium was about 5.5 percentage points. Put another way: for every €100 invested in 1900, bonds would have grown to €1,800, while equities would have generated over €100,000 over the same period. Index Balance calculates this automatically every time you update your portfolio.