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 measures return relative to volatility; it does not predict your worst loss. Two portfolios with the same Sharpe ratio can have very different drawdowns.
Compare ratios calculated over the same period, with the same return frequency and risk-free rate. Infrequently priced assets can look less volatile than they really are.
A higher risk-free rate lowers the excess return at the top of the formula. A portfolio can have a positive return and a negative Sharpe ratio if it earned less than the risk-free rate.
AllInvestView calculates the Sharpe Ratio automatically as part of its portfolio risk analysis. 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.