feel they are looking at a menu of investments, each with a unique level of risk. Do you want the petite filet, the regular size, or the carnivore special? They all sound good. The choice depends on your appetite for risk. However, looked at on a real after-tax basis, only one choice is likely to be very satisfying. The menu has changed a great deal. Do you want to maintain some cash balances? That will cost you. Do you want some insurance to lock in your level of wealth without too much risk? Bonds may be the answer. But if you want meaningful growth, better consider stocks or other higher-return assets. There are various participants in global bond and money markets. Pension funds and central banks are tax-exempt. Banks and insurance companies are subject to regulatory constraints that limit their participation in equity markets, driving them toward bonds and money markets. It may be the case that these participants establish market-clearing yield levels that make little sense to taxable clients. These data suggest that the equity risk premium has averaged about 7 percent on a pretax basis and 5 percent on a real after-tax basis. A number of observers believe that the premium has declined in recent years. Broader ownership of equities and more efficient capital markets may have contributed to this decline. Another distinction between past results and the current situation is that dividend yields have declined a great deal. In earlier times, investment analysts used dividend discount models to estimate the value of companies. Today, the P/E ratio is a more common measure of valuation. This decline is partly the result of the tax code. The effective tax rate on equities declines as dividends make up a smaller portion of total return. This means that the effective tax rate on equities has declined relative to taxable bonds and money market securities. Consequently, the after-tax equity risk premium is increasing relative to the pretax risk premium. This is an interesting phenomenon for the immediate purpose of our analysis. It is more troubling on a broader level. A tax code that encourages companies to retain earnings rather than distribute them to shareholders is likely to lead to a less efficient allocation of society's capital resources and thus to a lower growth rate. As we write this, President George W Bush has proposed eliminating tax on dividends. This change would obviously alter the calculation of expected after-tax return and would likely lead to an increase in dividend yields. INFLATION AND "SAFE" ASSETS Inflation reduces the purchasing power of an estate. Figure 30.2 shows the annual rate of U.S. inflation during the past 76 years. There have been two serious inflationary episodes. The first was associated with shortages during and after World War II. The second covered almost all of the 1970s and was caused, in part, by rising oil prices and rapid growth of the money supply. During each of these periods, inflation significantly reduced the real value of estates. During the 10 years ending December 1979, the purchasing power of Si was cut in half. In recent years inflation has been averaging about 3 percent. This destroys most or all of the after-tax return currently offered by many bonds and money market securities. Figure 30.3 shows that bonds had two periods of exceptionally good returns.