The Shrinking Premium

Anyone who follows my work knows that I have an aversion to Wall Street jargon. You won’t find me using terms like “standard deviation,” “Monte Carlo simulation,” or “risk-adjusted return.”

“Equity risk premium,” however, is one term that needs to be defined and understood. It is the difference in returns between stocks over bonds. Historically, investors have priced stocks to generate higher returns than bonds over the long haul. This is to compensate for enduring increased, short-term volatility.

In a July 31 Wall Street Journal article titled “The Benefit of Owning Stocks Over Bonds Keeps Shrinking,” its author revealed that with the increased yields on bonds, combined with lofty valuations on stocks, the expected equity risk premium is at its lowest level in 20 years.

Vanguard’s forward-looking returns essentially suggest the same.

Is it time to factor a shrinking “equity risk premium” into your portfolio and more importantly, into your financial plan? This decision could have a significant impact on your retirement well-being, depending on how you allocate and rebalance your portfolio between stocks and bonds in the years ahead.

Stay tuned – next week we will explore the equity risk premium and your financial plan.

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