Volitilities Role in The Equity Premium
I often talk with people about the differences between the long-term returns of bonds verses equities. Historically, bonds have returned about 6% and equities (judged by the S&P500) have average around 10%. That 4% difference is what is know as the equity premium. So why do equity investors demand a higher return than bond holders? It’s because of the yearly volatility associated with the equity market. The chart below illustrates this wonderfully. Even though the S&P500 has averaged about 10% since 1926, annually it has only come within two percentage points of that in just six years out of the past 94 years; with yearly returns as high as 54% and as low as 43%.
For enduring that wide range of annual returns, the equity investor demands a premium return. The real lesson here is that the only way to be rewarded by the equity market is to stay invested in good times and bad which is why the vast majority of investors significantly underperform the market. They just can’t handle the volatility. Lucky for us we are goal based, long-term investors with a plan that helps us stay on course in times of uncertainty. And it has been said that in the equity market the only certainty is uncertainty.
I hope you found this note to be informative and reassuring and if there if anything you would like to discuss please feel free to reach out to me. As always, it is my pleasure to work with you. Stay safe and have a great weekend!
David R Henderson
This is being provided for informational purposes only, and should not be construed as a recommendation to buy or sell any specific securities. Past performance is no guarantee of future results, and all investing involves risk. Index returns shown are not reflective of actual performance nor reflect fees and expenses applicable to investing. One cannot invest directly in an index. DCH Wealth Management, nor any of its members are tax accountants or legal attorneys, and do not provide tax or legal advice. For tax or legal advice, you should consult your tax or legal professional. The views expressed are those of DCH Wealth Management and do not necessarily reflect the views of Mutual Advisors, LLC or any of its affiliates.