Help Center

Home

Financial Terms and Glossary

Sharpe ratio

Sharpe Ratio

The Sharpe ratio is a financial metric used to assess the risk-adjusted return of an investment. It is calculated by dividing the excess return of the investment (over the risk-free rate) by its standard deviation, which represents the investment’s risk. A higher Sharpe ratio indicates that an investment provides better returns relative to its risk, while a lower ratio suggests less favorable risk-adjusted returns.

Example

An investor compares two mutual funds: Fund A has a Sharpe ratio of 1.5, and Fund B has a Sharpe ratio of 0.8. Fund A is deemed a better risk-adjusted investment.

Key points

• Measures risk-adjusted return.

• Higher Sharpe ratio indicates better returns relative to risk.

• Useful for comparing investments with similar risk profiles.

Quick Answers to Curious Questions

How can investors use the Sharpe ratio to evaluate investment performance?

It helps them assess whether an investment's returns are worth the risk taken to achieve them.

What does a negative Sharpe ratio indicate about an investment?

A negative ratio means the investment has underperformed relative to a risk-free rate, indicating poor performance.

How does the Sharpe ratio help compare two investments with different levels of risk?

It normalizes returns based on risk, allowing investors to compare how well each investment compensates for its risk level.

scroll top