Sharpe Ratio Calculator
Measure how well your portfolio compensates you for the risk you take. The Sharpe ratio divides excess return (above the risk-free rate) by the portfolio's standard deviation. A higher Sharpe ratio means better risk-adjusted performance.
The Sharpe ratio, developed by Nobel laureate William Sharpe, is one of the most widely used measures of risk-adjusted return. The formula is simple: (Rp - Rf) / sigma, where Rp is the portfolio return, Rf is the risk-free rate, and sigma is the portfolio's standard deviation.
For example, a portfolio returning 12% with a risk-free rate of 4.5% and standard deviation of 15% has a Sharpe ratio of 0.50. That means you earn 0.50 units of excess return for each unit of risk. Compare this to another portfolio returning 9% with a standard deviation of 5% -- its Sharpe ratio is 0.90, making it the better risk-adjusted choice despite the lower raw return.
Interpreting the Sharpe Ratio
- Below 0: The portfolio underperforms the risk-free rate. You would be better off in Treasury bills.
- 0 to 0.5: Poor risk-adjusted return. The risk is not well compensated.
- 0.5 to 1.0: Adequate. Typical for many diversified portfolios.
- 1.0 to 2.0: Good to very good. Indicates strong risk-adjusted performance.
- Above 2.0: Excellent. Rarely sustained over long periods.
The S&P 500 has historically produced a Sharpe ratio around 0.4-0.6 over long periods. Hedge funds and active managers who consistently achieve Sharpe ratios above 1.0 are considered top performers.