Sharpe Ratio Calculator

What the Sharpe Ratio Can Tell You

When comparing funds or portfolios, investors should consider both absolute returns and risks. While one portfolio or fund could have higher returns, it is only a good investment if those higher returns do not come with additional risk.

What is considered a good Sharpe Ratio largely depends on the investor's risk tolerance and investment objectives. Generally, any value greater than 1.0 is considered acceptable, while a ratio higher than 2.0 is considered very good, and a ratio of 3.0 or higher is considered excellent. However, it's important to note that a higher Sharpe Ratio may not always be better, as it could be a result of taking on excessive risk. Ultimately, investors should evaluate their portfolios based on their unique investment goals and risk tolerance, using the Sharpe Ratio as one of many tools for making informed investment decisions.

Sharpe Ratio Limitations

One of the main limitations of the Sharpe Ratio is its reliance on volatility as a measure of risk. It assumes that risk is synonymous with volatility, meaning that investments with high volatility are considered riskier than those with low volatility. However, this assumption may not always be accurate, as some investments with high volatility may not necessarily be riskier than those with low volatility.

It's worth noting that significant positive returns also count towards overall volatility and can consequently lower the Sharpe Ratio. It equally penalizes positive and negative deviations from the mean return. In other words, it doesn't distinguish between upside and downside volatility.

However, investors usually favor positive returns. Therefore, an investment with a high Sharpe Ratio but a low total return may not be as attractive to investors as an investment with a lower Sharpe Ratio but a higher total return. This is where other risk-adjusted performance indicators, such as the Sortino or Omega ratios, come in handy.

Alternatives

While the Sharpe Ratio is a helpful tool for evaluating your portfolio's risk-adjusted performance, there are other performance indicators you can use to make informed investment decisions. Here are a few alternatives:

Sortino Ratio: The Sortino Ratio is similar to the Sharpe Ratio but focuses on downside risk instead of overall volatility. It measures the excess return of an investment portfolio compared to the downward volatility, i.e., the volatility of portfolio returns that fall below a given level.

Treynor Ratio: The Treynor Ratio is another risk-adjusted performance indicator that evaluates an investment's returns relative to its systematic risk. It measures the excess return of an investment portfolio and divides it by its beta, which measures the portfolio's volatility relative to the whole market.

Omega Ratio: The Omega Ratio measures an investment portfolio's risk-adjusted performance. It is similar to other measures but takes into account the magnitude and frequency of negative returns, which can be more important to investors than overall volatility.

While these indicators provide valuable insights into an investment's risk-adjusted performance, using them with other tools and analysis is essential to make informed investment decisions.