The Sharpe Ratio measures risk-adjusted return by calculating the excess return per unit of volatility. It tells you how much additional return you earn for each unit of risk taken.
Sharpe Ratio = (Rp - Rf) / σp where Rp = portfolio return, Rf = risk-free rate, σp = portfolio standard deviation
If your portfolio returns 12%, the risk-free rate is 4%, and your portfolio standard deviation is 16%, your Sharpe Ratio is (12% - 4%) / 16% = 0.50. A Sharpe above 1.0 is considered good.
Sharpe assumes returns are normally distributed. In reality, stock returns have fat tails — a portfolio with Sharpe 1.5 can still experience a 40% drawdown that the Sharpe Ratio never predicted.
Comparing Sharpe across asset classes is misleading. A bond portfolio with Sharpe 0.8 may be genuinely better risk-adjusted than an equity portfolio with Sharpe 1.2, because bond returns are more normally distributed.
Sharpe is highly sensitive to the risk-free rate. When the risk-free rate jumped from 0.5% to 5% in 2022-2023, many portfolios' Sharpe Ratios turned negative — not because performance worsened, but because the denominator shifted.
AllInvestView calculates the Sharpe Ratio automatically on your portfolio analytics page. Customise the risk-free rate in Settings. Learn more in our portfolio returns guide.
Below 1.0 is subpar, 1.0-2.0 is good, 2.0-3.0 is very good, and above 3.0 is excellent. Most diversified portfolios fall between 0.5 and 1.5.
Sharpe penalises all volatility equally. Sortino only penalises downside volatility, making it a better measure when returns are skewed — most investors worry about losses, not gains.