Ok this might sound really stupid, but why do stocks have a positive real rate of return over time? If stock price is equal to the expected value of all future earnings, then 'because companies grow over time'(the explanation i hear the most) doesn't seem to make sense. Is it because you are getting paid a premium to take on the risk? Thanks
there is the combined reason of the macro fact that the economy grows over time or even better said, grows into something more sophisticated (there was a time when a bike was a sophisticated vehicle, then came trains and cars and planes) and the positive bias of selection in indices: stocks that don't perform well get kicked out and are replaced by stocks of companies that are doing well (at that moment in time at least) and are a better representation of the current economy. By the time they go bankrupt, most companies are not part of the major indices people watch anymore so there is this 'upside bias'.
It is quite possible that they don't, but there is this prevailing notion that they do which can be explained as the poster above me said by: 1. Growing economy over decades. 2. Growing inflation in the long run. Inflation also inflates stocks. Going back to the my first statements, that stocks actually go down in the long run, let's have a trip down on memory lane: http://en.wikipedia.org/wiki/Historical_components_of_the_Dow_Jones_Industrial_Average Only GE survived more than 100 years in the Dow, everything else was repeatedly replaced, so the index would keep going up....
yeah i'm talking about real rate so it's not inflation i agree that the data is often skewed in favor of upside because they delist stocks before they go bankrupt and often use data only since right after the great depression but don't stocks still have some small real rate of return? even if the economy 'progresses' from cars to planes, etc, to me stocks should already account for this because they are reflecting all future expectations. The only way they would consistently go up is if most expectation surprise came on the upside consistently... which also shouldn't happen theoretically
Long term, most of it is inflation and survivorship bias when looking at the indexes. In theory, retained earnings should increase the value of enterprises over time, but in reality most of that is stolen in the form of executive compensation, perks, and graft.
investing in equity must deliver on average a risk premium over credit. Otherwise the idea of capitalism would fail totally . Or in other words . No one would start any business if this would not be the case . And if no one would start a business it would again deliver a bigger risk premium.
1. Real GDP growth due to growth in TFP 2. Inflation 3. Survivorship bias 4. Secular shifts in investor preferences