# Sharpe Ratio

### What is Sharpe Ratio

The Sharpe ratio describes how much excess return you receive for the added volatility that you tolerate for holding on to a risky asset. 

It is calculated this way: S(x) = (rx-Rf)/StdDev(x) where: x = investment.

{% hint style="info" %}
a Sharpe ratio between 1 and 2 is considered good. A ratio between 2 and 3 is very good, and any result higher than 3 is excellent
{% endhint %}

| Sharpe Ratio   | Risk Rate | Verdict   |
| -------------- | --------- | --------- |
| Less than 1.00 | Very Low  | Poor      |
| 1.00 - 1.99    | High      | Good      |
| 1.99 - 2.99    | High      | Great     |
| 3.00 or Above  | High      | Excellent |

> The Sharpe ratio is an investment analysis tool that *indicates whether your risks are worth the returns your investment is providing*

### How to calculate it

You'll need to know your portfolio's **rate of return** in order to compute the Sharpe ratio

Secondly, you'll need the **rate risk-free investment**, like Treasury bonds. To get the rate at which your portfolio outperforms the Treasury bond, simply subtract this risk-free rate from your portfolio's rate of return.

Finally, subtract the **rate of return** from the **risk-free rate** and divide the result by the **standard deviation of the portfolio's excess return**.

<figure><img src="/files/ApzojXHzHl0U2tJcC61N" alt=""><figcaption><p>from businessinsider.com</p></figcaption></figure>

**Return of portfolio:** This is the return on investment (ROI) for your portfolio, or the expected return for a specific period of time.

**Risk-free rate:** This figure acts as your benchmark, or what you would've earned without virtually any risk. The Sharpe ratio often uses Treasury securities here because of their unlikeliness to default. For example, you might use a 5-year Treasury note rate to calculate the Sharpe ratio for your 5-year portfolio.

**Standard deviation:** This measurement of volatility indicates how much a return fluctuates over a period of time. Expressed as a positive number, the [standard deviation](https://www.businessinsider.com/personal-finance/what-is-standard-deviation) accounts for both downside and upside changes.&#x20;

"The impetus behind the ratio is taking standard deviation and volatility to find a simple numerical value," says Randy Frederick, Schwab managing director of trading and derivatives.

Volatility is often understood as a bad thing, Frederick points out. But really, volatility means you're seeing price upsides along with downsides over time. The Sharpe ratio takes these factors and spits out a number that can tell you how your investments are doing relative to the risk.

### sharpe Ratio example

Let's say you have an ETF with a 5-year, 30% return (*Rp* = 30).&#x20;

Meanwhile, the 5-year Treasury has a rate of 0.83% (*Rf* = 0.83).&#x20;

In this example, let's assume the standard deviation is 20% (*σp* = 20).&#x20;

Now we can fill out the Sharpe ratio calculation.

*Sharpe ratio* = (30 – 0.83) ÷ 20

*Sharpe ratio* = 29.17 ÷ 20

*Sharpe ratio* = 1.46

With a solid Sharpe ratio of 1.46, you know the volatility your ETF weathers is being more than offset by your additional return.

check out [Sortino Ratio](/glossary/indexing/sortino-ratio.md)


---

# Agent Instructions: Querying This Documentation

If you need additional information that is not directly available in this page, you can query the documentation dynamically by asking a question.

Perform an HTTP GET request on the current page URL with the `ask` query parameter:

```
GET https://bwb.sirfitech.org/glossary/indexing/sharpe-ratio.md?ask=<question>
```

The question should be specific, self-contained, and written in natural language.
The response will contain a direct answer to the question and relevant excerpts and sources from the documentation.

Use this mechanism when the answer is not explicitly present in the current page, you need clarification or additional context, or you want to retrieve related documentation sections.