The Sharpe Ratio Formula Calculator calculates the excess return per unit of deviation in a hazardous investment. Allowing you to better understand the investment’s return concerning its risk.

The Sharpe Ratio Formula can help you determine how appealing a hazardous financial investment is. In other words, the hazardous Investment Sharpe Ratio is equal to the volatility of net worth.

The Sharp ratio calculation is closely into the Capital Asset Pricing Model (CAPM). This financial term helps determine your asset or investment’s expected return based on its inherent risk level. You are interested in how to calculate it, how to find the Sharpe ratio, Sharpe ratio formula, don’t worry we are here for you! Also, check this other finance related posts, such as WACC Calculator, or DuPont Analysis tool.

Sharpe Ratio – Definition

So what is Sharpe ratio, and who created it? Nobel Laureate William F. Sharpe created the Sharpe ratio. We can use it to assist investors in assessing a finance investment’s return versus its risk portfolio. The return earned more than the rate per unit of volatility or overall risk is the ratio. Volatility is a measure of an asset’s or portfolio’s price changes.

Sharpe Ratio Formula

Take the portfolio’s return and subtract the risk-free rate, such as U.S. Treasury rate or yields, like the one-year or two-year Treasury yield. Next, subtract the result from the portfolio’s excess return’s standard deviation. The standard deviation is a measurement of how far the portfolio’s return differs from the expected return. The standard deviation also reveals the portfolio’s volatility.

So the basic Sharpe ratio equations and the formulas for calculating the value of the shape ratio are:

Sharpe  Ratio = \frac {Risk Premium} {σ​​}
Risk Premium = RA - RF

Sharpe Ratio Interpretation – What Does It Tell You?

An investor can better isolate the earnings associated with risk-taking activities by subtracting the risk-free rate from the mean return. The risk-free rate of return is the rate of return on investment with no risks. For example, the rate of return investors may anticipate if they don’t take any risks. The risk-free rate, for example, may be the yield on a US Treasury bond portfolio.

One of the most extensive approaches that are used for determining risk-adjusted return is the Sharpe ratio. According to Modern Portfolio Theory (MPT), adding assets to a diversified portfolio with low correlations can reduce portfolio risk without compromising return.

In comparison to similar portfolios with a lesser level of diversification, adding diversification should improve the ratio also. This is true if investors accept the assumption that risk equals volatility. Which is logical but may be too restrictive to apply to all assets. When we determine the real returns in the formula, the ratio may analyze a portfolio’s previous performance (ex-post).

Alternatively, an investor might generate an anticipated Sharpe ratio using predicted portfolio performance and the expected risk-free rate. We may also use the Sharpe ratio to determine if a portfolio’s excess returns are the consequence of sound investment selections or excessive risk value. Even if a portfolio or fund earns better returns than its peers, it is only a sound investment, provided those higher gains are not accompanied by excessive risk.

The Sharpe ratio of a portfolio determines its risk-adjusted-performance. If the Sharpe ratio is negative, it signifies that the risk-free rate is higher than the portfolio’s return or that the portfolio’s return is mostly to be negative. A negative ratio does not offer any helpful information in either instance.

Sharpe Ratio and Sortino Ratio – Difference

The Sortino Ratio, which excludes the impacts of upward price movements on standard deviation to focus on the distribution of returns below the goal or necessary return, is a version of the Sharpe ratio. The risk-free rate is in the numerator of the Sortino ratio by other eturn. Making the formula the portfolio return less the required return, divide by the distribution of returns below the goal or required return.

The Treynor Ratio, which employs a portfolio’s beta or correlation with the rest of the market, is another variant of the Sharpe ratio. In comparison to the entire market, beta measures an investment’s volatility and risk. We can also use the Treynor ratio to measure whether an investor is paid for accepting more risk beyond the market’s inherent risk. We can find the Treynor ratio by dividing the portfolio’s return minus the risk-free rate by the portfolio’s beta. Be sure to check out our Investment Calculator, to found some interesting facts about the investment and other calculators also.

Information Ratio vs. Sharpe Ratio

The information ratio compares a financial asset’s or portfolio’s risk-adjusted returns to a certain benchmark. The goal of this ratio is to indicate excess returns relative to the benchmark and the consistency with which the excess returns.

The tracking error measures the consistency with which excess returns are generated. Fund managers as a performance indicator largely utilize the information ratio. We also use it to compare the capabilities and abilities of fund managers that have comparable investing methods. In addition, the ratio informs investors about a fund manager’s capacity to consistently generate excess or even abnormal (as in “abnormally large”) returns over time.

Finally, usage of the information ratio is by some hedge funds and mutual funds to compute the fees they charge their clients (e.g., performance fee). The Sharpe ratio and the information ratio are comparable. We can use both ratios to find a security’s or portfolio’s risk-adjusted returns. On the other hand, the information ratio compares risk-adjusted returns to the risk-free rate, and the Sharpe ratio compares risk-adjusted returns to a specific benchmark.

Sharpe Ratio – How to Calculate?

Our Sharpe Ratio Formula Calculator will provide you everything. We can find the Sharpe ratio is easily in the fact sheet of a mutual fund. We can determine the Sharpe ratio by subtracting the risk-free return from the portfolio return, which we know as the excess return.

After that, the excess return is in two parts by the portfolio’s standard deviation. It’s a statistic for measuring the increased profit from each additional unit of threat taken. We determine it monthly and then annualized for ease of understanding in most cases.

If a fund’s Sharpe ratio is 1.25, it suggests that for every 1% increase in financial value yearly volatility, the fund delivers an additional 1.25 percent return. To maintain a higher Sharpe ratio, a fund with a greater standard deviation should earn better returns. A fund with a smaller standard deviation, on the other hand, can obtain a higher Sharpe ratio by continuously achieving modest returns.

Sharpe Ratio Formula Calculator – Example

For you to better understand this Sharpe Ratio Formula Calculator we will provide an example. An investor may want to add a hedge fund allocation to their existing portfolio. Which is now between equities and bonds and has a return of 15% over the previous year.

The current risk-free rate is 3.5 percent, and the portfolio’s return volatility was 12 percent, resulting in a Sharpe ratio of 95.8%, or (15 percent – 3.5 percent) divided by 12 percent.

The investor predicts that including the hedge fund in the portfolio will reduce the predicted return to 11% for the following year while simultaneously lowering the portfolio’s volatility to 7%. As a result, they expect the risk-free rate to stay unchanged in the coming year. Using the same calculation and the predicted future statistics, the investor discovers that the portfolio’s Sharpe ratio is 1.07 percent, or (11% – 3.5%) divided by 7%.

FAQ

How to calculate the Sharpe ratio?

Subtract the risk-free rate from the portfolio’s return. For example, a US Treasury rate or yields, such as the one-year or two-year Treasury yield, might be used as the mentioned rate. Then, divide the result by the portfolio’s excess return standard deviation.

What does a Sharpe ratio of 0.5 mean?

Your asset would have a portfolio ratio of 0.5 if it theoretically earned 7.5 percent per year over the risk-free rate with a standard deviation of roughly 15%. Investor biases, poor decision-making, and bad habits are the primary causes of low Sharpe ratios and poor returns.

What is the Sharpe ratio?

The Sharpe ratio is a financial metric that compares the performance of an investment, such as a securities or a portfolio, to that of a risk-free asset after risk is taken into account.

What does the negative Sharpe ratio tell you?

If the ratio is negative, it signifies that the risk-free rate is higher than the portfolio’s return or that the portfolio’s return is predicted to be negative.

What is a good Sharpe ratio?

Investors often regard any ratio more than 1.0 to be acceptable to good. A ratio of more than 2.0 is considered excellent. A 3.0 or greater ratio is regarded as excellent. A Sharpe ratio that is less than 1.0 is deemed sub-optimal.