Dividend Yields Are Equity Risk Premiums: Practical Implications for Financial Planners

Abstract

In 1984, in The Journal of Portfolio Management, Michael Rozeff suggested that expected equity risk premium can be proxied by the current dividend yield on the market. Thirty years later, his results are updated and expanded, based on this study of the performance of 16 stock markets since 1970. The evidence shows that long-term equity returns are still predictable with the Divided Yield Method: Financial planners should use it to achieve realistic expected stock returns. This apparent predictability should be explained theoretically through a rational economic perspective, an approach that has important implications for the asset allocation decision. In the context of the current financial situation, the expected future return may be lower than in the past, but is still attractive, given the low level of inflation and risk-free interest rate in many countries.