--- title: Risk Premium | Formula, Example, Conclusion, Calculator description: The risk premium is the return on an investment minus the return on a risk-free investment. Click for more information. --- [![Carbon collective](https://www.carboncollectiveinvesting.com/hubfs/raw_assets/public/CarbonCollective_August2021%20copy/images/carbon-collective-green-investing-logo-white.4f6047d4.svg "Carbon collective")](https://www.carboncollectiveinvesting.com/) - About - Employers - [Sustainable 401(k)](https://www.carboncollectiveinvesting.com/401k) - [401(k) Comparison Tool](https://www.carboncollectiveinvesting.com/401k/plan-comparison-tool) - Individuals - [FAQ](https://www.carboncollective.co/en/knowledge/faqs) - [ETF](https://www.carboncollectivefunds.com/) - Learn - [Sustainable Investing](https://www.carboncollective.co/sustainable-investing) - [Investing Basics](https://www.carboncollective.co/sustainable-investing/investing-basics) - [Blog](https://blog.carboncollective.co/) - [Tools](https://tools.carboncollective.co/calculator/) - Log in - [Carbon Collective](https://app.carboncollective.co) - [Altruist](https://app.altruist.com) [Talk to a human](https://ask.carboncollective.co/f4o5dylkg) [Sign up](https://app.carboncollective.co/sign-up) [Log In](http://app.carboncollective.co/) [![Carbon collective](https://www.carboncollectiveinvesting.com/hubfs/raw_assets/public/CarbonCollective_August2021%20copy/images/carbon-collective-green-investing-logo.53b28bee.svg "Carbon collective")](https://www.carboncollectiveinvesting.com/) - About - Employers - [Sustainable 401(k)](https://www.carboncollectiveinvesting.com/401k) - [401(k) Comparison Tool](https://www.carboncollectiveinvesting.com/401k/plan-comparison-tool) - Individuals - [FAQ](https://www.carboncollective.co/en/knowledge/faqs) - [ETF](https://www.carboncollectivefunds.com/) - Learn - [Sustainable Investing](https://www.carboncollective.co/sustainable-investing) - [Investing Basics](https://www.carboncollective.co/sustainable-investing/investing-basics) - [Blog](https://blog.carboncollective.co/) - [Tools](https://tools.carboncollective.co/calculator/) - Log in - [Carbon Collective](https://app.carboncollective.co) - [Altruist](https://app.altruist.com) [Talk to a human](https://ask.carboncollective.co/f4o5dylkg) [Sign up](https://app.carboncollective.co/sign-up) [Log In](http://app.carboncollective.co/) **[Home](https://www.carboncollectiveinvesting.com/) > [Sustainable Investing](https://www.carboncollectiveinvesting.com/sustainable-investing) >** Risk Premium # Risk Premium ![](https://www.carboncollectiveinvesting.com/hubfs/Brooke%20Tomasetti.png) Written by Brooke Tomasetti | Reviewed by [Subject Matter Experts](https://www.carboncollectiveinvesting.com/subject-matter-experts) Updated on October 1, 2024 Fact Checked Why Trust Carbon Collective? ### Table of Contents A risk premium is a [return on investment](https://www.carboncollectiveinvesting.com/sustainable-investing/return-on-investment/) above the risk-free rate that an investor needs to be compensated for investing in higher-risk investments. Put simply, the more risk an investment has, the higher the return an investor needs to make it worthwhile. It’s also known as the risk premium equation of the default risk premium and is commonly used by investors and finance students who deal with the financial markets. Risk premium is used to calculate how much a potential investor needs to be compensated for taking on extra risk when compared to a lower “risk-free” investment. [![Learn how to select a portfolio and understand risk as an individual investor.](https://hubspot-no-cache-na2-prod.s3.amazonaws.com/cta/default/20345524/b7fdf313-8ef3-408b-8a56-f67204703b0a.png)](https://hubspot-cta-redirect-na2-prod.s3.amazonaws.com/cta/redirect/20345524/b7fdf313-8ef3-408b-8a56-f67204703b0a) Typically, the US treasury bill (T-bill) is used as the risk-free rate in the US, but in finance theory the risk-free rate is any investment which has no risk. ## Risk Premium Formula ![](https://www.carboncollectiveinvesting.com/hubfs/image-png-May-11-2022-02-47-12-41-AM.png) - ra = Return on asset/investment - rf = Risk-free return The risk premium of an investment is calculated by subtracting the risk-free return on investment from the actual return on investment and is a useful tool for estimating expected returns on relatively risky investments when compared to a risk-free investment. ### Market Risk Premium The market’s risk premium is the average market return less the risk-free rate. For shares, the word “market” can be connoted as a whole stock index such as the S&P 500 or the Dow. The risk premium on the market may be shown as: ![2-Apr-23-2022-03-58-04-97-PM](https://www.carboncollectiveinvesting.com/hs-fs/hubfs/2-Apr-23-2022-03-58-04-97-PM.png?width=1456&name=2-Apr-23-2022-03-58-04-97-PM.png) - Rm = Market return - Rf = Risk-free return The market risk is called systematic risk. Unsystematic risk, on the other hand, is the amount of risk associated with a particular investment and is not market-related. The amount of risk approaches that of the market as an investor diversifies their investment portfolio. The many clichés about diversifying the investment portfolio are extracted from systemic and unsystematic uncertainty and its relationship to returns. ### Risk Premium on a Stock Using CAPM The risk premium for a particular investment using the [capital asset pricing model](https://www.carboncollectiveinvesting.com/sustainable-investing/capital-asset-pricing-model/) is beta times the difference between market return and risk-free return on investment. ![3-Apr-23-2022-03-58-17-56-PM](https://www.carboncollectiveinvesting.com/hs-fs/hubfs/3-Apr-23-2022-03-58-17-56-PM.png?width=1456&name=3-Apr-23-2022-03-58-17-56-PM.png) - ERi = Expected return of investment - Rf = Risk-free rate - Bi = Beta of the investment - (ERm – Rf) = Market risk premium As noted earlier, market risk premium refers to the return on the market minus the return on a risk-free investment and it’s used in CAPM to factor in the systematic risk of an investment ## Risk Premium Example Amy is planning to invest $50,000 in order to get a large return. With the financial crisis, she is very aware of the potential risk and wants to strike an investment balance between risk and return. She has the option to invest in risk-free investments like the US treasury bond which returns 3% a year, and also has the option to invest in a uranium stock, which is higher risk but has a potential 21% return. Let’s calculate Amy’s risk premium: ![](https://www.carboncollectiveinvesting.com/hubfs/image-png-May-11-2022-02-47-31-76-AM.png) ![5-Apr-23-2022-03-58-42-33-PM](https://www.carboncollectiveinvesting.com/hs-fs/hubfs/5-Apr-23-2022-03-58-42-33-PM.png?width=1457&name=5-Apr-23-2022-03-58-42-33-PM.png) ![6-Apr-23-2022-03-58-52-55-PM](https://www.carboncollectiveinvesting.com/hs-fs/hubfs/6-Apr-23-2022-03-58-52-55-PM.png?width=1455&name=6-Apr-23-2022-03-58-52-55-PM.png) So here we see that Amy has a risk premium of $9,000. This is a rough estimate of expected returns on the risky investment into uranium. It’s important to note that this is completely dependent on the performance of the stock and Amy would need to better understand the risk factors by studying the stock at length to decide whether it’s worth investment and if it can realize the risk premium return of $9,000. ## Risk Premium Conclusion When calculating risk premium, the below points are worth bearing in mind as a quick recap of what it is, why it’s used, and how to use it: - The risk premium is the return on an investment minus the return on a risk-free investment. - The market’s risk premium is the average market return less the risk-free rate. - For shares, the word “market” can be connoted as a whole stock index such as the S&P 500 or the Dow. - The market risk is called systematic risk. Unsystematic risk, on the other hand, is the amount of risk associated with a particular investment and is not market-related. - The risk premium for a particular investment using the capital asset pricing model is beta times the difference between market return and risk-free return on investment. ## Risk Premium Calculator You can use the risk premium calculator below to work out your own risk premium by entering the investment amount, the investment rate, and the risk-free rate.   Investment Amount (R) Investment Rate (a) Risk-free Rate (f) Risk Premium ## FAQs ### 1. What is a risk premium? A risk premium is the extra return on an investment over and above the risk-free rate you would get for investing in Treasury bonds. It is also referred to as "expected excess return". ### 2. What are the three types of risk premium? The systematic risk premium, unsystematic risk premium, and country risk premium. ### 3. Is a higher risk premium better? No. A risk premium measures the returns on an investment relative to a risk-free investment like US treasury bonds, so it's just about comparing investments with different levels of risk. The higher the risk, the more you should expect in return because there is always a trade off between reward and risk. ### 4. How does risk premium affect the stock price? A stock's price is determined by many factors, and how risky it is or what the market expects for its risk premium has a major role in determining the share price. ### 5. Why does risk premium change? Risk premium changes with the return of the market. Also, risk factors for investment can change over time and this can affect its required rate of return or its risk premium. ### Related Topics - [Sustainable 401(k) Plan](https://www.carboncollective.co/401k) - [Sustainable Investing](https://www.carboncollective.co/sustainable-investing/) - [Investing Basics](https://www.carboncollective.co/sustainable-investing/investing-basics) - [Retirement Glossary](https://www.carboncollective.co/sustainable-investing/retirement-planning-glossary) - [Best Retirement Plans](https://www.carboncollective.co/sustainable-investing/the-10-best-retirement-plans) - [Wealth Manager Vs Financial Advisor](https://www.carboncollective.co/sustainable-investing/wealth-manager-vs.-financial-advisor) ![Attend Our Next Webinar](https://www.carboncollectiveinvesting.com/hubfs/carbon-collective-green-investing-icon-webinar.12af7b6e.svg) ### Attend Our Next Webinar Join our next Sustainable Investing 101 webinar, get our favorite DIY options, and walk through how we build our portfolios. [Watch Now](https://www.carboncollective.co/sustainable-investing-webinar-green-retirement-month) ![Get Our Newsletter](https://www.carboncollectiveinvesting.com/hubfs/carbon-collective-green-investing-icon-demo.6ed28722.svg) ### Get Our Newsletter Go a level deeper with us and investigate the potential impacts of climate change on investments like your retirement account. Join Newsletter ![close-typeform](data:image/gif;base64,R0lGODlhEQARAIAAAODn7P///yH5BAEHAAEALAAAAAARABEAAAIqBIKpab3v3EMyVHWtWZluf0za0XFNKDJfCq5i5JpomdUxqKLQVmInqyoAADs=) ![Talk To A Human](https://www.carboncollectiveinvesting.com/hubfs/carbon-collective-green-investing-icon-chat.49d48c5b.svg) ### Talk To A Human Joining a new investment service can be intimidating. We’re here for you. Click below to email us a question or book a quick call. [Ask a Question](https://ask.carboncollective.co/f70pooobq) Topics ## Sustainable Investing Topics View our list of some topics below. See More - Portfolios - [Performance](https://www.carboncollectiveinvesting.com/returns) - About - [Sustainable 401(k)](https://www.carboncollectiveinvesting.com/401k) - Learn - [FAQ](https://www.carboncollective.co/en/knowledge/faqs) - [Sustainable Investing](https://www.carboncollective.co/sustainable-investing) - [Investing Basics](https://www.carboncollective.co/sustainable-investing/investing-basics) - Contact - [Contact us](mailto:hello@carboncollective.co) - [Legal](https://www.carboncollective.co/legal) - [Privacy Policy](https://www.carboncollectiveinvesting.com/hubfs/2022-11%20Carbon%20Collective%20Privacy%20Policy.pdf) - [Back to top](https://www.carboncollectiveinvesting.com/sustainable-investing/risk-premium#top-of-page) DISCLAIMERS: Advisory services provided by Carbon Collective Investment LLC (“Carbon Collective"), an SEC-registered investment adviser. A copy of Carbon Collective's current written disclosure statement discussing Carbon Collective’s business operations, services, and fees is available at the SEC’s investment adviser public information website – [www.adviserinfo.sec.gov](https://adviserinfo.sec.gov/firm/summary/310129) or [our legal documents here](https://blog.carboncollective.co/legal-documents/). The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. Carbon Collective does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Carbon Collective’s web site or incorporated herein, and takes no responsibility therefor. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Investments in securities: Not FDIC Insured • No Bank Guarantee • May Lose Value. Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. Before investing, consider your investment objectives and Carbon Collective's charges and expenses. Carbon Collective's internet-based advisory services are designed to assist clients in achieving discrete financial goals. They are not intended to provide comprehensive tax advice or financial planning with respect to every aspect of a client's financial situation and do not incorporate specific investments that clients hold elsewhere. For more details, see our Form CRS, Form ADV Part 2 and other disclosures. Past performance does not guarantee future results, and the likelihood of investment outcomes are hypothetical in nature. Not an offer, solicitation of an offer, or advice to buy or sell securities in jurisdictions where Carbon Collective is not registered. © 2026 Carbon Collective Corporation. All rights reserved. × #### Fact Checked Carbon Collective partners with financial and climate experts to ensure the accuracy of our content. Our team of reviewers are established professionals with years of experience in areas of personal finance and climate. They have contributed to top tier financial publications, such as Reuters, Axios, Ag Funder News, Bloomberg, Marketwatch, Yahoo! Finance, and many others. This team of experts helps Carbon Collective maintain the highest level of accuracy and professionalism possible. × #### Why Trust Carbon Collective Carbon Collective is the first online investment advisor 100% focused on solving climate change. We believe that sustainable investing is not just an important climate solution, but a smart way to invest. We follow ethical journalism practices, which includes presenting unbiased information and citing reliable, attributed resources. Much of our research comes from leading organizations in the climate space, such as Project Drawdown and the International Energy Agency (IEA). Our goal is to deliver the most understandable and comprehensive explanations of climate and finance topics. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications. Our work has been directly cited by organizations including MarketWatch, Bloomberg, Axios, TechCrunch, Forbes, NerdWallet, GreenBiz, Reuters, and many others. We strive to empower readers with the most factual and reliable climate finance information possible to help them make informed decisions. } ```json { "@context" : "https://schema.org", "@type" : "Organization", "alternateName" : "Carbon Collective", "contactPoint" : { "@type" : "ContactPoint", "areaServed" : "US", "availableLanguage" : "en", "contactType" : "customer service", "telephone" : "(650) 868-2697" }, "logo" : "https://www.carboncollective.co/hubfs/CarbonCollectiveLogo.png", "name" : "Carbon Collective Investing LLC", "sameAs" : [ "https://www.facebook.com/carboncollectiveinvesting/", "https://twitter.com/carbncollective", "https://www.instagram.com/carbon.collective/", "https://www.youtube.com/channel/UC769Y-F-L_B37kyQfdpvyXA", "https://www.linkedin.com/company/carbon-collective/", "https://www.crunchbase.com/organization/carbon-collective", "https://adviserinfo.sec.gov/firm/summary/310129", "https://www.wikidata.org/wiki/Q110243690" ], "url" : "https://www.carboncollective.co/" } ``` ```json { "@context" : "https://schema.org", "@type" : "FAQPage", "mainEntity" : [ { "@type" : "Question", "acceptedAnswer" : { "@type" : "Answer", "text" : "A risk premium is the extra return on an investment over and above the risk-free rate you would get for investing in Treasury bonds. It is also referred to as \"expected excess return\"." }, "name" : "What is a risk premium?" }, { "@type" : "Question", "acceptedAnswer" : { "@type" : "Answer", "text" : "The Systematic risk premium, unsystematic risk premium, and country risk premium." }, "name" : "What are the three types of risk premium?" }, { "@type" : "Question", "acceptedAnswer" : { "@type" : "Answer", "text" : "No. A risk premium measures the returns on an investment relative to a risk-free investment like US treasury bonds, so it's just about comparing investments with different levels of risk. The higher the risk, the more you should expect in return because there is always a trade off between reward and risk." }, "name" : "Is a higher risk premium better?" }, { "@type" : "Question", "acceptedAnswer" : { "@type" : "Answer", "text" : "A stock's price is determined by many factors, and how risky it is or what the market expects for its risk premium has a major role in determining the share price." }, "name" : "How does risk premium affect the stock price?" }, { "@type" : "Question", "acceptedAnswer" : { "@type" : "Answer", "text" : "Risk premium changes with the return of the market. Also, risk factors for an investment can change over time and this can affect its required rate of return or its risk premium." }, "name" : "Why does risk premium change?" } ] } ``` ```json { "@context" : "https://schema.org", "@type" : "BlogPosting", "author" : { "@type" : "Person", "name" : "https://20345524.fs1.hubspotusercontent-na1.net/hubfs/20345524/Brooke%20Tomasetti.png", "url" : "https://www.carboncollectiveinvesting.com/sustainable-investing/author/brooke-tomasetti" }, "dateModified" : "2024-10-01", "datePublished" : "2021-03-24", "description" : "The risk premium is the return on an investment minus the return on a risk-free investment. Click for more information.", "headline" : "Risk Premium | Formula, Example, Conclusion, Calculator", "image" : "", "mainEntityOfPage" : { "@id" : "https://www.carboncollectiveinvesting.com/sustainable-investing/risk-premium", "@type" : "WebPage" }, "publisher" : { "@type" : "Organization", "logo" : { "@type" : "ImageObject", "url" : "https://www.carboncollective.co/hubfs/CarbonCollectiveLogo.png" }, "name" : "Carbon Collective" } } ```