inal rate is between 4 and 5 percent. These projected real returns are
lower than the 3^1 ⁄ 2 percent average compound real return on U.S. long-
term government bonds over the past 205 years, but they are not as low
as they were during the postwar period.
The excess return for holding equities over short-term bonds is
plotted in Figure 1-5, and it is referred to as the equity risk premium, or
simply the equity premium.^16 The equity premium, calculated as the dif-
ference in 30-year compound annual real returns on stocks and bills, av-
eraged 1.4 percent in the first subperiod, 3.4 percent in the second
subperiod, and 5.9 percent since 1926.
The abnormally high equity premium since 1926 is certainly not
sustainable. It is not a coincidence that the highest 30-year average eq-CHAPTER 1 Stock and Bond Returns Since 1802 17
(^16) For a rigorous analysis of the equity premium, see Jeremy Siegel and Richard Thaler, “The Equity
Premium Puzzle,” Journal of Economic Perspectives, vol. 11, no. 1 (Winter 1997), pp. 191–200, and
more recently, “Perspectives on the Equity Risk Premium,” Financial Analysts Journal, vol. 61, no. 1
(November/December 2005), pp. 61–73, reprinted in Rodney N. Sullivan, Bold Thinking on Invest-
ment Management, CFA Institute, 2005, pp. 202–217.
FIGURE 1–5
Equity Risk Premium (30-Year Compound Annual Moving Average, 1831 through December 2006)
-2%
0%
2%
4%
6%
8%
10%
12%
14%
1831 1841 1851 1861 1871 1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001
Stock Minus Bond Returns
Stock Minus Bill Returns