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Sharpe Ratio Formula:
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The Sharpe Ratio is a measure of risk-adjusted return that helps investors understand the return of an investment compared to its risk. It was developed by Nobel laureate William F. Sharpe and is widely used in finance to compare the performance of investment portfolios.
The calculator uses the Sharpe Ratio formula:
Where:
Explanation: The ratio measures excess return per unit of risk. Higher values indicate better risk-adjusted performance.
Details: The Sharpe Ratio is crucial for comparing investment opportunities, evaluating portfolio performance, and making asset allocation decisions. It helps investors understand whether higher returns are due to smart investment decisions or excessive risk-taking.
Tips: Enter all values in decimal form (e.g., 8% = 0.08). Portfolio standard deviation must be greater than zero. The result is dimensionless (unitless).
Q1: What is a good Sharpe Ratio?
A: Generally, a ratio above 1.0 is considered good, above 2.0 is very good, and above 3.0 is excellent. However, interpretation depends on the investment context.
Q2: What time period should be used?
A: Typically, annualized returns and standard deviation are used, but the ratio can be calculated for any time period as long as all inputs are consistent.
Q3: What risk-free rate should I use?
A: Common proxies include 3-month Treasury bill rates or the rate on short-term government securities in your currency.
Q4: Are there limitations to the Sharpe Ratio?
A: Yes, it assumes normal distribution of returns and doesn't distinguish between upside and downside volatility. It may not be appropriate for non-normal return distributions.
Q5: How does this differ from the Sortino Ratio?
A: The Sortino Ratio only considers downside deviation, while Sharpe Ratio considers total standard deviation.