What is a reasonable return?
Updated: Nov 18, 2020
Equity Risk Premium is the difference in return between riskier share investments and less risky government securities. It’s a critical concept because most of us are risk averse – we might be prepared to take more risk but only if we are compensated for that added risk.
In 2019, the Reserve Bank of Australia (RBA) estimated the equity risk premium in Australia over the 102 year period 1917 to 2019 to be approximately 4% p.a. The research can be found here:
If your shares portfolio does better than the risk free rate plus the equity risk premium then you are doing well.
Australian Bond Yields can be located on Bloomberg’s website here:
The RBA has used 10 year Australian Government Bonds to represent the risk free rate. On 9 November 2020 that rate was 0.8%, meaning if your portfolio has been generating returns better than 4.8% on a sustained basis then you are doing better than we should reasonably be expecting. For investments which are more volatile we would expect a slightly higher return.
With central banks suppressing interest rates we have bought forward returns which otherwise we would have paid less for if discount rates were higher. For this reason our return assumptions looking forward several years from this point should reflect what is possible.