Excess Return

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The part of your return that exists because you took risk.

Quick Answer

What is Excess Return?

Excess return is the portion of your portfolio return above the risk-free rate. If T-bills yielded 4% and your portfolio earned 9%, your excess return is 5%. It is the numerator of the Sharpe ratio and represents the compensation for the risk you actually took — anything below it could have been earned riskless.

Excess Return = Rp − Rf

Formula

Excess Return = Rp − Rf
Rp = portfolio return (annualized) · Rf = risk-free rate (typically the 3-month T-bill yield)

Trivially simple to compute. The interesting choice is what to use as the risk-free rate — Foliolytic uses actual daily T-bill yields from FRED, not a fixed 2% or 3%.

Intuition — what is this number telling you?

This is the metric that puts every other return in context. A 7% portfolio in a 1% T-bill environment (2021) was meaningfully different from a 7% portfolio in a 5% T-bill environment (2024). The first earned 6% of excess; the second earned 2%. Same nominal return, very different reward for risk.

Worked example

Step-by-step

Your portfolio earned 11.2% annualized over a window in which the average T-bill yield was 4.6%.

Excess return = 11.2% − 4.6% = 6.6%

That is the return you earned for accepting equity risk. The other 4.6% you could have gotten for free in a money market fund.

What's a good Excess Return value?

Long-run equity risk premium (the excess return for owning stocks vs. T-bills) has been roughly 5–7% per year over the past century in US data. In any specific decade it can range from negative to over 10%. Anything sustained above 7% over a long window is exceptional.

Related metrics

Sharpe Ratio  ·  Risk-Free Rate  ·  Alpha (Jensen's)  ·  Active Return

Frequently asked questions about Excess Return

What is the equity risk premium?

The expected excess return for owning stocks vs. risk-free Treasury bills. Historical US estimate is roughly 5–7% per year, with wide variance.

What risk-free rate does Foliolytic use?

Actual daily 3-month Treasury bill yields from FRED, matched to the time period of your portfolio. We do not use a fixed assumption.

Can excess return be negative?

Yes — when your portfolio underperforms the risk-free rate. In 2022, many portfolios had negative excess return because T-bills were yielding 4-5% while stocks were down.

Is excess return the same as alpha?

No. Excess return is just Rp − Rf. Alpha (Jensen's) is the part of excess return not explained by beta exposure to the market.

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