What is a good Sharpe ratio in investing?

What is a good Sharpe ratio? A Sharpe ratio less than 1 is considered bad. From 1 to 1.99 is considered adequate/good, from 2 to 2.99 is considered very good, and greater than 3 is considered excellent . The higher a fund's Sharpe ratio, the better its returns have been relative to the amount of investment risk taken.

How to interpret the results of Sharpe ratio?

The Sharpe ratio is calculated by subtracting the risk-free rate of return from the expected rate of return, then dividing the resulting figure by the standard deviation. A Sharpe ratio of 1 or better is good, 2 or better is very good, and 3 or better is excellent .

What is the Warren Buffett Sharpe ratio?

Two Other Factors Boosted Buffett's Performance The AQR researchers found that Berkshire Hathaway's Sharpe Ratio (a measure of returns after adjusting for risk) is 0.79 from 1976-2017 .

What does a Sharpe ratio of 1.5 mean?

A Sharpe ratio of 1.5 indicates that the investment is generating 1.5 units of excess return for each unit of risk taken, relative to the risk-free rate . It implies better risk-adjusted performance than a lower Sharpe ratio.

What does Sharpe tell you?

The Sharpe ratio, created by Nobel Laureate William F. Sharpe in 1966, helps investors evaluate a particular asset's volatility so they can identify which investment might provide the best returns based on their risk tolerance . "The Sharpe ratio is a useful tool for investors who want to balance risk and return.

Does Sharpe ratio really matter?

Typically, the higher the Sharpe ratio, the more attractive the return and the better the investment . However, if the calculation results in a negative Sharpe ratio, it means one of two things: either the risk-free rate is greater than the portfolio's return, or the portfolio should anticipate a negative return.

What are the disadvantages of the Sharpe ratio?

The problem with the Sharpe ratio is that it is accentuated by investments that don't have a normal distribution of returns . The best example of this is hedge funds. Many of them use dynamic trading strategies and options that give way to skewness and kurtosis in their distribution of returns.

What is the Sharpe ratio of the S&P 500?

The current S&P 500 Sharpe ratio is 2.34 . This value is calculated based on the past 1 year of trading data and takes into account price changes and dividends.

What is the Sharpe ratio of the spy?

Risk & Volatility Measures Capture Ratios Investment Index Beta 0.98 0.99 R 2 99.51 99.73 Sharpe Ratio 0.88 0.82 Standard Deviation 13.48 13.35 1 more row

Is it better to have a higher Sharpe ratio?

Generally, the higher the Sharpe ratio, the more attractive the risk-adjusted return . The Sharpe ratio can be used to evaluate a portfolio's risk-adjusted performance. Alternatively, an investor could use a fund's return objective to estimate its projected Sharpe ratio ex-ante.

What is the Sharpe ratio of the S&P?

The current S&P 500 Portfolio Sharpe ratio is 2.46 . This value is calculated based on the past 12 months of trading data and takes into account price changes and dividends.

What the Sharpe Ratio Means for Investors (2024)

What Is the Sharpe Ratio?

The Sharpe ratio measures the risk-adjusted return on an investment or portfolio, developed by the economist William Sharpe. The Sharpe ratio can be used to evaluate the total performance of an investment portfolio or the performance of an individual stock.

The Sharpe ratio compares how well an equity investment performs to the rate of return on a risk-free investment, such as U.S. government treasury bonds or bills.

Key Takeaways

The Sharpe ratio compares how well an equity investment performs to the rate of return on a risk-free investment.
To calculate the Sharpe ratio, calculate the expected return on an investment portfolio or individual stock and then subtract the risk-free rate of return.
A higher Sharpe ratio may indicate good investment performance, given the risk.

What the Sharpe Ratio Means for Investors (1)

Understanding the Sharpe Ratio

Since William Sharpe created theSharpe ratioin 1966, it has been a popular risk-return measure used in finance due to its simplicity. Professor Sharpe won a Nobel Memorial Prize in Economic Sciences in 1990 for his work on thecapital asset pricing model (CAPM).

Formula

To calculate the Sharpe ratio, calculate the expected return on an investment portfolio or individual stock and then subtract the risk-free rate of return.

Divide that figure by the standard deviation of the portfolio or investment. The Sharpe ratio can be recalculated at the end of the year to examine the actual return rather than the expected return.

Sharpe Ratio Formula

$\begin{aligned}&\text{Sharpe Ratio}=\frac{\text{Rx}-\text{Rf}}{\text{StdDev Rx}}\\&\textbf{where:}\\&\text{Rx}=\text{Expected portfolio return}\\&\text{Rf}=\text{Risk-free rate of return}\\&\text{StdDev Rx}=\text{Standard derivation of the}\\&\qquad\quad\text{portfolio's return or its volatility}\end{aligned}$ SharpeRatio=StdDevRxRx−Rfwhere:Rx=ExpectedportfolioreturnRf=Risk-freerateofreturnStdDevRx=Standardderivationoftheportfolio’sreturnoritsvolatility

Example

Assume a mutual fund has an expected return over time of 25%. A risk-free rate of return is 2.70%. The standard deviation is 20%. Under these circ*mstances, the Sharpe ratio calculation is:

$\begin{aligned}\frac{25 - 2.70}{20} = 1.11\end{aligned}$ 2025−2.70=1.11

A Sharpe ratio greater than one but less than two indicates acceptable performance compared to the performance of the risk-free investment.

Using the Sharpe Ratio

Measure Risk-Adjusted Performance: Instead of looking at the overall return, the Sharpe ratio hones in the money made relative to the risk.
Compare Investments: Investors can use the Sharpe ratio to compare the risk-adjusted performance of different investments.
Optimize Portfolios: Portfolio managers utilize the Sharpe ratio to optimize the allocation of assets within a portfolio.
Evaluate Performance: Investors can evaluate whether or not the risk profile matches their risk appetite.
Benchmark: Investors often use the Sharpe ratio to compare the performance of a portfolio or investment against a benchmark, such as a market index.
Rank Risk: Investors can rank different investments or portfolios based on risk. This ranking can help identify which assets are more likely to incur losses.
Plan Hedging Strategies: Investors can use the Sharpe ratio to decide which assets they want to hold onto and then plan to hedge or protect themselves against potential losses.

The Sharpe ratio is used in so many different contexts. The U.S. Commodities Futures Trading Commission analyzed high frequency trading activity and evaluated a Sharpe ratio of 4.3 for firms specializing in this activity.

Ratio Variations

Modified Sharpe Ratio: This variation modifies the traditional Sharpe ratio by replacing the standard deviation in the denominator with a downside risk measure. This places more emphasis on the downside risk.
Sortino Ratio: The Sortino ratio is similar to the Modified Sharpe Ratio but focuses on downside risk instead of prioritizing it. It also uses the standard deviation of negative returns in the denominator.
M2 Measure: The M2 Measure introduces a risk aversion parameter into the Sharpe ratio formula. It incorporates an investor's risk preferences by allowing for a subjective assessment of risk aversion.
Omega Ratio: The Omega ratio considers the entire distribution of returns and calculates the probability-weighted ratio of gains to losses. It provides a more comprehensive view of risk and return.
Treynor Ratio: Instead of using total risk in the denominator, the Treynor ratio uses beta, which represents the systematic risk of an investment relative to the market.
Upside Potential Ratio (UPR): The UPR focuses on the potential upside of an investment by comparing the average gain to the average loss.

What Does a Sharpe Ratio of Less Than 1 Mean?

A Sharpe ratio of less than one is considered unacceptable or bad. The risk a portfolio encounters isn't being offset well enough by its return. The higher the Sharpe ratio, the better.

Can Investors Use the Sharpe Ratio to Evaluate a Single Investment?

Yes, the Sharpe ratio is useful as a way to compare investments. It is also often used by institutional investors managing large portfolios for many investors to maximize returns without taking on excessive risk.

What Does the Sharpe Ratio Indicate?

It can indicate how well an investment in equities performs when compared to the return offered by an essentially risk-free investment over the long term. It can help improve investment decision-making as investors take steps to improve portfolio performance.

What Are the Limitations of the Sharpe Ratio?

The main problem with the Sharpe ratio is that it is accentuated by investments that don't have anormal distributionof returns. Asset prices have zero downside but have unlimited upside potential, making their returns right-skewed or log-normal. The Sharpe ratio assumes that asset returns are normally distributed. Many hedge funds use dynamic trading strategies and options that give way to skewness and kurtosis in their distribution of returns. A simple strategy of selling deepout-of-the-money options tends to collect small premiums and pay out nothing until the "big one" hits. Until a big loss, this strategy would erroneously show a very high and favorable Sharpe ratio.

The Bottom Line

The Sharpe ratio is a metric used in finance to evaluate the risk-adjusted performance of an investment. It's calculated as the ratio of the difference between the investment's return and the risk-free rate to the standard deviation of its returns. Investors use the Sharpe ratio to evaluate whether an investment earns the appropriate amount of money, based on the risk.