Tuesday, April 8, 2008

What is the world equity risk premium?

John Campbell of Harvard has a nice paper published in a Canadian Econ Journal that estimates the equity risk premium. His conclusion: the world (and US) equity premium is around 4% currently.

The article isn't free, but if you are have access to a university library you can probably download it for free.

Given a 30 year bond rate of about 4.3%, this implies a long term return to stocks in the US of 8.3%. Why does this matter??? Well if you are assuming a 40 year investment horizon (someone who is, say 25 now) and you contribute $1,000 a month, 8.3% return will give you about $3.8M in your portfolio at age 65. But if you were using 11% (the long run historical return on equities) you would be expecting $8.6M. Given that most people are not saving enough, a lower return on stocks is not going to help.