Michael Mauboussin explains the important roles luck and skill play in investment success and how to harness both to your advantage in a recent interview with Consuelo Mack. The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing. Brief excerpt followed by the video below:
HIGH EQUITY RISK PREMIUM
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“I struggle with this, because I think today the most interesting anomaly that I see continues to be what is high equity risk premium. So in plain words, you think of a risk-free rate of return. In the United States, a 10-year Treasury note is a good proxy for that. And that’s today about a 1.8% yield. An equity risk premium is the return above and beyond that you would expect for taking on additional risk on equities. Now, over the long haul, that equity risk premium has been about three or four percent, something like that, and today, by most reckoning, it’s a lot closer to six percent. It’s very, very high. So to me, I don’t know if it’s bonds going down, in other words, yields going up because bonds going down, or stocks going up or some combination of these two things, but I have to believe, if you said to me three to five years what’s a good thing to bet on, I think it’s going to be that equity risk premium shrinking… so it could be, again, because of bonds doing poorly, equities doing well or some combination thereof.
Yeah, so I mean, go long equities would be one answer, but it’s really the relationship between equities and bonds I think is the most… equities versus bonds.”