About Sharpe Ratio Calculator (Formula)
A Sharpe Ratio Calculator is a tool used to evaluate the risk-adjusted performance of an investment or portfolio. This ratio, developed by Nobel laureate William F. Sharpe, measures the excess return earned by an investment per unit of risk taken. It helps investors assess whether the returns generated are sufficient given the level of risk involved.
The formula for calculating the Sharpe Ratio involves the excess return of the investment and the standard deviation of its returns:
Sharpe Ratio = (Portfolio Return – Risk-Free Rate) / Portfolio Standard Deviation
Where:
- Sharpe Ratio is a measure of risk-adjusted performance.
- Portfolio Return is the average return generated by the investment or portfolio.
- Risk-Free Rate represents the return on a risk-free investment, often a government bond.
- Portfolio Standard Deviation measures the volatility of the investment’s returns.
To use the Sharpe Ratio Calculator formula, follow these steps:
- Calculate the average return of the investment or portfolio over a specific period.
- Determine the risk-free rate, usually the return on a government bond considered risk-free.
- Calculate the standard deviation of the investment’s returns, representing its volatility.
- Plug the values of portfolio return, risk-free rate, and portfolio standard deviation into the formula: Sharpe Ratio = (Portfolio Return – Risk-Free Rate) / Portfolio Standard Deviation.
- Calculate the Sharpe Ratio. The result provides insight into the investment’s risk-adjusted performance.
A higher Sharpe Ratio indicates better risk-adjusted performance, as it implies higher returns for the level of risk taken. Investors can use this ratio to compare different investment opportunities and portfolios, choosing those with more favorable risk-return profiles.
Keep in mind that the Sharpe Ratio has limitations, such as assuming a normal distribution of returns and not considering non-linear risks. It’s best used in conjunction with other risk and performance metrics.