Investing term

What is Risk premium?

The extra return investors demand for taking on risk, over and above what cash pays.

The risk premium is the extra return investors demand for taking on risk, above the return from safe cash or government bonds. Because no one would accept the volatility and possible losses of a risky asset for the same return as a safe one, riskier assets must offer more — and that expected extra is the premium.

It's the reward for enduring uncertainty, and it's why stocks have historically out-earned cash and bonds over long horizons. No premium is guaranteed in any given year — that's precisely why it's a reward for risk rather than a sure thing — but bearing risk sensibly is how investors earn more than the risk-free rate over time.

The reward for taking risk
Safe bondsthe risk-free base4%Stocks (expected)base + risk premium9%The 5-point gap over safe bonds is the equity risk premium — pay for a bumpier ride.

If safe bonds yield 4% and stocks are expected to return 9%, that 5-point gap is the equity risk premium — the extra return that pays you for a bumpier ride.

For example

If safe bonds yield 4% and investors expect 9% from stocks, that 5-point gap is the equity risk premium — payment for the bumpier ride.

Learn it by doing

That's Risk premium in theory — it clicks when you use it. Practise it hands-on in a free, interactive lesson (Stage 2, Why Investing Matters (And When It Doesn't)).

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Why it matters to you

The risk premium is the engine of long-term investing: it's the reason holding volatile assets is rewarded rather than merely nerve-wracking. Understanding it reframes volatility as the price you pay to earn the premium, not a bug to be eliminated — remove all the risk and you remove the extra return with it. It also sets a sanity check: an investment promising high returns with no risk is either mispriced or a scam.

⚠ Expecting the premium every year

The risk premium is a long-run average, not a yearly entitlement. Over any given year or even several, risky assets can and do underperform safe ones — that possibility is the risk you're being paid for. Treating the premium as guaranteed leads to overconfidence and panic when the reward doesn't show up on schedule.

Frequently asked questions

What is a risk premium?

It's the extra expected return investors require for holding a risky asset instead of a safe one. For stocks, the equity risk premium is the amount by which their expected return exceeds safe government bonds — compensation for the greater volatility and chance of loss.

Why do stocks have a risk premium?

Because they're riskier than cash or government bonds — their prices swing and they can fall for years. Investors won't hold that risk unless they expect to be paid more for it, so stocks must offer a higher expected return. That expected excess is the equity risk premium.

Is the risk premium guaranteed?

No. It's an expected long-run reward, not a yearly promise. Over short periods risky assets can underperform safe ones — that possibility is exactly the risk being compensated. The premium tends to show up over long horizons, which is why patience is central to earning it.

Related terms

Asset classA broad category of investment with similar behavior. Stocks, bonds, cash, real estate, commodities.Behavior gapThe difference between a fund's reported return and what its investors actually earned — usually worse.Dollar-cost averagingInvesting a fixed amount on a fixed schedule, regardless of market level.FOMO buyingFear of missing out — piling into something after it has already run, because everyone else seems to be winning.
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