Negative Risk Premiums

You may have come across the term “negative risk premium” in your search for viable investments with which to fund your future retirement. In the realm of investments, a negative risk premium occurs when a relatively safe or low-risk investment pays bigger premiums than a riskier one. Over time, yields of risk premiums are positive, for the most part, although some cases may see negative shifts due to market fluctuations and other associated conditions. Now, what happens when your premium goes negative?

Risk premiums need to maintain a positive footing to be able to give investors rewards for taking on the said risk. If the negative status of a risk premium lasts, this may mean that market conditions are, and will be unfavorable, for some time. This is bad for investors because the risk premium’s entire point is the goal of larger returns or higher rates of return on related investments due to the additional risk – if risk-free investment returns pay bigger premiums compared to a riskier investment, the investor’s incentive for investing in riskier opportunities is rendered useless.

Negative risk premiums can be illustrated by stock market investments. Stocks, which typically have higher risk premiums than bonds because of the added inherent risk carried by the former, can generate profits much lower than what you can get with relatively safer bonds – here, a negative risk premium is in play. In this case, investors may believe that stocks yield less profit than currently possible with bonds.

In a time that stocks, for example, are ruled by negative risk premiums, it won’t be a good idea to invest. Conditions may be too risky, and can result in the loss of your principal investment, not to mention the lack of profit. Consult with your financial planner or investment advisor for other investment options, or wait until market conditions become more conducive.

Puritan Financial Group has years of experience in dealing important financial decisions. Puritan Financial Group will listen to you and your loved ones and craft a custom financial solution that supports your life goals.

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