1. What is the Sharpe Ratio?

The Sharpe ratio measures the performance of an investment compared to a risk-free asset, after adjusting for its risk. It is defined as the difference between the returns of the investment and the risk-free return, divided by the standard deviation of the investment returns.

2. How Does the Calculator Work?

The calculator uses the Sharpe ratio formula:

Where:

• \( Excess\ Return \) — Return above the risk-free rate (expressed as decimal)
• \( Risk \) — Standard deviation of the investment's excess return (expressed as decimal)

Explanation: The ratio represents the excess return per unit of risk taken. Higher values indicate better risk-adjusted performance.

3. Importance of Sharpe Ratio

Details: The Sharpe ratio is widely used in finance to compare the risk-adjusted returns of different investments or portfolios. It helps investors understand whether higher returns are due to smart investment decisions or excessive risk.

4. Using the Calculator

Tips: Enter excess return and risk as decimals (e.g., 0.08 for 8%). Risk must be greater than zero.

5. Frequently Asked Questions (FAQ)

Q1: What is a good Sharpe ratio?
A: Generally, a ratio of 1.0 or higher is considered good, 2.0 or higher is very good, and 3.0 or higher is excellent.

Q2: Can the Sharpe ratio be negative?
A: Yes, a negative ratio indicates that the risk-free asset would perform better than the investment.

Q3: What time period should be used?
A: Typically monthly returns are used, but any consistent time period can be used as long as the same period is used for all calculations.

Q4: What are the limitations of the Sharpe ratio?
A: It assumes returns are normally distributed and that investors only care about volatility as a measure of risk.

Q5: How does this differ from the Sortino ratio?
A: The Sortino ratio only considers downside risk, while Sharpe ratio considers total volatility.