The Sharpe ratio divides a portfolio's excess returns by a measure of its volatility to assess risk-adjusted performance. This article will discuss, "Sharpe Ratio Formula: What is The Sharpe Ratio?" Let's get started.
What is The Sharpe Ratio?
The Sharpe ratio is a measurement that gives investors insights into investments' performances. The ratio analyzes performance over the long term, to help investors get a return that may not be the greatest possible, but is still good enough when downturns arise.
The Sharpe ratio is largely used by hedge funds and investment managers, rather than everyday investors since they manage large portfolios and want to maximize customers' returns without too much volatility.
Sharpe Ratio Formula
So, the Sharpe ratio formula is,
{R (p) – R (f)}/s (p)
Please note that here,
R (p) = Portfolio return
R (f) = Risk-free rate-of-return
s (p) = Standard deviation of the portfolio
In other words, amid multiple funds with similar returns, the one with a greater standard deviation possesses a lesser Sharpe index. So, it must produce a higher return to balance the greater deviation and sustain the higher ratio. Also, adding new underlying assets can stimulate the total portfolio return with no extreme risk.
Though practically impossible, the investment with a 10% annual return and zero volatility has an infinite Sharpe index. So, the predicted return must substantially increase with surged volatility to nullify the additional risk.
Sharpe Ratio Formula: What is The Sharpe Ratio? - hopefully, this article can help you to get some knowledge.
