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Sharpe Ratio

Risk-adjusted return: excess return divided by volatility.

The Sharpe ratio measures how much excess return (above the risk-free rate) an investment provides per unit of risk (standard deviation). Higher Sharpe ratios indicate better risk-adjusted performance. It's commonly used to compare portfolios or strategies.

Formula
Sharpe=E[rp]−rfσp\text{Sharpe} = \frac{E[r_p] - r_f}{\sigma_p}
Where
E[rp]E[r_p]=Expected portfolio return
rfr_f=Risk-free rate
σp\sigma_p=Portfolio volatility
Variables
SRSharpe ratio
E[R_p]Expected portfolio return (annualized)
R_fRisk-free rate (annualized)
\sigma_pPortfolio volatility (annualized)
Assumptions
  • Risk-free rate input by user (default 4%)
  • Returns are normally distributed
  • Excess return is the only measure of value
  • Volatility is the only measure of risk
vs. Industry Tools
Morningstar — Uses same formula; may adjust for survivorship bias
Related Terms

Efficient Frontier

The set of portfolios offering the highest return for each level of risk.

Portfolio Volatility

Standard deviation of portfolio returns — total risk including diversification effects.

Maximum Sharpe Portfolio

The portfolio with the highest risk-adjusted return.

Monte Carlo Simulation

Generating thousands of possible future scenarios through random sampling.