Every investor wants higher returns, but there’s no such thing as a free lunch on the ASX. The concept of risk premium is at the heart of every investment decision, from picking blue-chip shares to weighing up property syndicates or emerging green tech. In 2025, with shifting interest rates, market volatility, and regulatory tweaks, understanding risk premium is more crucial than ever for Australians looking to build wealth or safeguard their super.
What Is Risk Premium—and Why Should You Care?
Risk premium is the extra return investors demand for taking on additional risk over a ‘risk-free’ asset (like an Australian government bond). In other words, it’s the reward for facing uncertainty. For example, if a 10-year government bond yields 4%, and the expected return on the ASX 200 is 8%, the risk premium for investing in shares over bonds is 4%.
- Shares vs Bonds: Shares are riskier, so they offer a higher expected return (the risk premium).
- Property vs Term Deposits: Direct property investment typically demands a higher risk premium compared to the safety of a term deposit.
- Emerging Tech vs Blue Chips: High-growth, speculative sectors require a larger risk premium to justify the additional risks involved.
In 2025, the RBA’s ongoing cycle of interest rate adjustments and global market jitters have made the calculation of risk premiums even more dynamic. Many fund managers are now re-evaluating their models as inflation expectations settle and economic growth slows.
How Is Risk Premium Used in Investment Decisions?
Risk premium isn’t just a theoretical number. It’s a practical tool used by fund managers, financial advisers, and even self-directed investors to decide where to put their money. Here’s how:
- Portfolio Construction: Allocating between shares, bonds, property, and alternatives based on the risk premium expected from each asset class.
- Valuing Investments: Discounted cash flow (DCF) models use risk premium to set the discount rate, affecting how companies and projects are valued.
- Assessing Market Conditions: When the risk premium widens (e.g., due to geopolitical tensions or a property downturn), investors may demand even higher returns or shift to safer assets.
Case Study: In early 2025, several Australian infrastructure funds recalculated their required risk premium after the Federal Government announced stricter climate risk disclosure rules. The increased regulatory uncertainty led to higher expected returns for new infrastructure projects, but also made some investors more cautious.
Risk Premium Trends and Policy Updates in 2025
This year has brought notable shifts affecting risk premiums:
- Interest Rates: The RBA’s current cash rate of 4.1% means the baseline for ‘risk-free’ returns is much higher than in previous years, lifting the bar for all risk premiums.
- Superannuation Guidance: APRA’s 2025 update to MySuper performance tests now considers risk-adjusted returns, putting extra pressure on underperforming funds to justify their risk premiums.
- Market Volatility: Ongoing global uncertainty—think supply chain pressures, new trade pacts, and tech sector disruption—has led to greater dispersion in risk premiums across sectors. For instance, ASX-listed lithium miners have seen their risk premiums spike after fluctuating global demand forecasts.
Smart investors in 2025 are keeping a close eye on these moving parts. It’s not just about chasing the highest return, but understanding how much extra risk you’re accepting—and whether you’re being adequately rewarded for it.
Making Risk Premium Work for You
Whether you’re a seasoned investor or just starting out, here’s how you can use risk premium to shape smarter decisions:
- Compare Options: Always weigh the risk premium against your personal risk appetite and financial goals. Don’t be tempted by high potential returns without considering the underlying risks.
- Stay Informed: Monitor policy changes, RBA moves, and market signals that influence the risk premium on your investments.
- Review Regularly: As your circumstances or the market shift, so too does the appropriate risk premium for your portfolio. Rebalance as needed.
