Sharpe ratio
InvestingDefinition
The best-known measure of risk-adjusted return. It answers: how much return am I getting per unit of risk? Divide your excess return (return minus the risk-free rate) by your volatility. A higher number is better.
Rule of thumb: a Sharpe of 1.0 is decent, 2.0 is strong, 3.0 is elite and probably unsustainable. The S&P 500 has a long-run Sharpe of around 0.5. A Sharpe of 0.5 is what you get for bearing ordinary stock-market risk.
Rule of thumb: a Sharpe of 1.0 is decent, 2.0 is strong, 3.0 is elite and probably unsustainable. The S&P 500 has a long-run Sharpe of around 0.5. A Sharpe of 0.5 is what you get for bearing ordinary stock-market risk.
Formula
Sharpe = (Portfolio return minus risk-free rate) divided by Portfolio standard deviation
Example
Fund A returns 12% per year with 20% volatility. Risk-free rate is 4%. Sharpe = (12% minus 4%) divided by 20% = 0.4. Fund B returns 10% with 8% volatility. Sharpe = (10% minus 4%) divided by 8% = 0.75. Fund B earns more return per unit of risk.