Calculate the Sharpe ratio from portfolio return, risk-free rate, and standard deviation to assess risk-adjusted performance.
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Portfolio Analysis
The Sharpe ratio measures how much excess return a portfolio earns per unit of total risk (standard deviation). It is the most widely used risk-adjusted performance metric in finance.
Developed by Nobel laureate William Sharpe in 1966, the ratio answers a simple question: how much return are you getting for the volatility you are bearing? A higher Sharpe ratio means better risk-adjusted returns.
The Sharpe ratio is used to compare portfolios, funds, and strategies on a level playing field — a fund with a 20% return and 40% volatility is not necessarily better than one with 10% return and 8% volatility.
Excess return divided by total volatility.
Sharpe Ratio = (Rp − Rf) / σ
Rp = portfolio return, Rf = risk-free rate, σ = standard deviation of portfolio returns.
Portfolio return 12%, risk-free rate 4.5%, standard deviation 15%. Sharpe = (12 − 4.5) / 15 = 0.50.
Below 0: portfolio underperformed the risk-free asset. 0–0.5: poor to marginal risk-adjusted return. 0.5–1.0: acceptable. 1.0–2.0: good. Above 2.0: excellent (rare for sustained periods).
Assumes returns are normally distributed. Penalises upside volatility equally with downside volatility. Uses a single risk-free rate which may not match the investment horizon. The Sortino ratio addresses the upside penalty issue.
Frequently asked questions
Use the yield on a government bond matching your evaluation period. For annual returns, use the 1-year Treasury yield. For longer horizons, use the 10-year Treasury. The key is consistency when comparing portfolios.
Above 1.0 is generally considered good. The S&P 500’s long-run Sharpe ratio is roughly 0.4–0.6. Sustained ratios above 2.0 are exceptional and may indicate measurement issues or overfitting.
Standard deviation captures all deviations from the mean, including large positive returns. For strategies with positive skew (e.g. trend-following), the Sortino ratio is a better metric because it only measures downside risk.
Only if they are annualised consistently. A monthly Sharpe of 0.2 is not comparable to an annual Sharpe of 0.5. Annualise by multiplying the monthly Sharpe by √12 ≈ 3.46.
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