Common stock equity market returns have varied widely in the past. The common stock equity risk premium has averaged about 4.1% from 1872 to 2000.
The equity risk premium is the equity market return less the risk free rate of return. The risk free rate of return includes both the inflation rate and the risk free interest rate. When it is subtracted from the market return, the resulting figure is the real or non-inflationary equity risk premium. For more information about the risk free rate, Click Here >> How are asset class risk premiums and the risk free rate of return related?
Measured by calendar decades over the past 130 years, common stock equity premium was over 10% in four decades, between 0% and 5% in seven decades and negative in two decades.
Interestingly, for these calendar decades the risk premium was never between 5% and 10%. Instead, returns were most often relatively close to the average or they were a bust. The four exceptional high stock market return decades were the post-World War I and II periods and the 1990′s economic boom period.
In a related article, What have average investment asset class risk premiums been over long periods? it was noted that real or non-inflationary equity market returns have averaged almost 7% annually over the past 200 years. However, the composition of these equity returns has changed, as the average risk free interest return has declined and the corresponding equity risk premium has increased on average.
Historically, both the risk free rate of return and the equity risk premium have fluctuated significantly.
Table 1 below illustrates these patterns. Table 1 presents the annualized averages for each decade over the past 130 years. These data are selected from a table in “The Equity Premium” study by Professors Eugene F. Fama of the University of Chicago and Kenneth R. French of Dartmouth.1
Table 1 — Historical Real Equity Risk Premiums (Compounded Average Annual Rates)
Inflation (%/year) (A) Risk Free Rate of Return* (B) Real S&P Index Return (B less A) Real Equity Risk Premium 1872-1880 -2.77 9.86 13.42 3.56 1881-1890 -1.72 7.23 5.08 -2.15 1891-1900 .18 5.08 9.15 4.08 1901-1910 1.95 3.18 6.78 3.60 1911-1920 6.82 .82 -.83 -1.64 1921-1930 -1.70 7.41 17.54 10.13 1931-1940 -1.23 2.80 7.52 4.72 1941-1950 6.04 -4.57 8.22 12.79 1951-1960 1.79 1.05 15.32 14.27 1961-1970 2.94 2.27 5.90 3.63 1971-1980 8.11 -.30 2.12 2.42 [...]