Sharpe Ratio

The golden industry standard for risk-adjusted return

What is the Sharpe Ratio?

Named after American economist, William Sharpe, the Sharpe Ratio (or Sharpe Index) is commonly used to calculate the performance of an investment by adjusting for its risk.

The higher the ratio, the greater the return of portfolio relative to the risk taken, and thus the better the investment. The Sharpe Ratio can be used to evaluate a single stock or investment, or an entire portfolio.

Use this premade Sharpe ratio calculator to easily calculate the Sharpe Ratio or visit our Excel template section to find templates for other formulas.

Sharpe Ratio formula

Sharpe Ratio = (Rx – Rf) / StdDev Rx

Where:

  • Rx = Expected portfolio return
  • Rf = Risk free rate of return
  • StdDev Rx = Standard deviation of portfolio return / volatility​

Sharpe Ratio Grading Thresholds:

  • Less than 1: Bad
  • 1 – 1.99: Adequate/good
  • 2 – 2.99: Great
  • Greater than 3: Excellent

Application of Sharpe Ratio

An investment portfolio can consist of shares, bonds, ETFs, deposits, precious metals or other instruments. Each instrument has its underlying risk and return, which will influence the ratio.

For example, a hedge fund manager has a portfolio of stocks with a ratio of 1.70. The fund manager decides to add some commodities to diversify and modify the composition to 80/20 stock and commodities, which pushes the Sharpe ratio up to 1.90. While the addition might be risky, it pushes the ratio up and should be added to the portfolio. If the addition pushes the ratio down, the investment instrument should not have been added to the portfolio.

Another example, where there are two managers A and B. Manager A has a portfolio return of 20% while B has a return of 30%. S&P 500 performance is 10%. Although it looks like B performs better in terms of return, when we look at the Sharpe Ratio, it turns out that A has a ratio of 2 while B only 0.5. This number means B take more risk than A, which may explain his higher returns, but also means he has a higher chance of making losses.