Sharpe Ratio

Formula

Sharpe ratio = mean excess return / standard deviation of excess returns

Excess return is the portfolio return minus the risk-free return for the same period. With a constant risk-free rate, subtracting it leaves the standard deviation unchanged. Use the same return frequency, period and benchmark when comparing ratios.

Example

With a 12% mean portfolio return, a constant 4% risk-free return and 16% portfolio return standard deviation, the Sharpe ratio is (12% − 4%) / 16% = 0.50.

Related Measures

Interpretation

A negative ratio means mean return was below the risk-free rate in a historical calculation. A higher ratio generally indicates more excess return per unit of volatility in a comparable positive-excess-return comparison. There is no universal cutoff for a good ratio. Standard deviation treats gains and losses symmetrically. A historical ratio depends on the sample and does not show how an investment will interact with an investor's other holdings.

William Sharpe's explanation