Published Friday, January 13, 2023 at: 7:07 PM EST
With the bear market turning eight months old on Friday, and stocks 16.6% lower than their previous all-time high on January 3, 2022, it’s wise to remember that putting up with stock volatility has been well worth the risk over the past two decades.
The equity risk premium illustrated here shows the reward received annually for tolerating the risk of owning stocks versus owning a risk-free investment. Stocks, as measured by the Standard & Poor’s 500, averaged a 9.8% annual return in the 20 years — more than seven times the 1.2% annualized return on risk-free 90-day U.S Treasury bills. Subtracting the average annual return on T-bills from the return on stocks, the resulting 8.6% is the premium paid annually for taking the risk of owning U.S. stocks over the past 20 years.
To be clear, T-bills are considered a risk-free investment because they’re backed by the full faith and credit of the United States Government. In contrast, stock market investments are not guaranteed. Stock prices fluctuate, depending on the economy and investor sentiment about the future, and stocks are subject to large, unpredictable drops in their value. In fact, if all 500 companies in the S&P 500 index were to go bust, an investment in a mutual fund or exchange traded fund mimicking the blue-chip index could be lost. In addition, no guarantee can be made that the high return on stocks will be repeated in the future. For all these reasons, stocks are a risky investment, and that is why stocks pay a premium over a riskless investment.
The S&P 500 stock index closed Friday at 3,999.09 gaining +0.40% from Thursday, and up +2.67% from a week ago. The index is up +78.7% from the pandemic bear market low on March 23, 2020, .and -16.6% lower than its January 3, 2022, all-time high.
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