1. What is the Sharpe Ratio?

The Sharpe ratio measures risk-adjusted return of an investment or portfolio. It represents the excess return per unit of volatility or total risk. Developed by Nobel laureate William F. Sharpe, it helps investors understand the return of an investment compared to its risk.

2. How Does the Calculator Work?

The calculator uses the Sharpe ratio formula:

Where:

• \( Return \) — Investment return (decimal)
• \( RiskFree \) — Risk-free rate (decimal)
• \( SD \) — Standard deviation of investment returns (decimal)

Explanation: The ratio subtracts the risk-free rate from the investment return to determine the excess return, then divides by the standard deviation (volatility) of the investment's returns.

3. Importance of Sharpe Ratio

Details: A higher Sharpe ratio indicates better risk-adjusted performance. It allows comparison between different investments or portfolios with different risk levels. Generally:

• Below 1.0 is considered poor
• 1.0-2.0 is good
• Above 2.0 is excellent
• Above 3.0 is exceptional

4. Using the Calculator

Tips: Enter all values as decimals (e.g., 8% = 0.08). Standard deviation must be greater than zero. Annualized returns and standard deviations are typically used.

5. Frequently Asked Questions (FAQ)

Q1: What risk-free rate should I use?
A: Typically use the current yield on 3-month Treasury bills. For historical calculations, use the risk-free rate from the same period as your returns.

Q2: What time period should be used?
A: The ratio is most meaningful when calculated using annualized returns and standard deviation over the same time period (e.g., 3-5 years).

Q3: Can Sharpe ratio be negative?
A: Yes, when returns are below the risk-free rate. This indicates the investment performed worse than a risk-free asset.

Q4: What are limitations of the Sharpe ratio?
A: It assumes normal distribution of returns and that volatility equals risk. It may not fully capture tail risks or be appropriate for non-normal return distributions.

Q5: How does it compare to Sortino ratio?
A: Sortino ratio is similar but only considers downside volatility, which may be more relevant for investors primarily concerned with downside risk.