Excess Returns

The usual basic balance people seek when investing: risk vs. reward. If you take on more risk, you should demand more reward as compensation. Reward = returns. To put it another way, the more likely it is that you’ll lose money, the higher the payoff needs to be in order to entice you to accept the increased chance of a bad outcome.

“Excess returns” is a concept that captures this balance. Excess returns measure the amount an investment pays off compared to the lowest-risk investment out there.

Buying U.S. Treasury bonds is usually considered a virtually risk-free investment. In the modern era, Treasury Bonds are returning about 2%, pre-tax. You decide to put your money in an investment with a 10% return (say, an S&P 500 index fund, bought near the bottom of a bearish market). The excess return on that other investment is 8%...you get eight percentage points more return than you would just parking your money in a Treasury at 2%. That's "excess," Wall Street style.