Sharpe Ratio Calculator

The Sharpe Ratio is the most widely used measure of risk-adjusted return. It answers a critical investing question: “How much excess return am I earning per unit of risk taken?” A higher Sharpe ratio means better return for the same level of volatility.

Formula: Sharpe Ratio = (Portfolio Return − Risk-Free Rate) ÷ Portfolio Standard Deviation

Where:

• Portfolio Return (Rp) — the annualized return of the investment or strategy
• Risk-Free Rate (Rf) — the return of a risk-free asset (typically 3-month US Treasury bills; ~5% in 2024)
• Standard Deviation (σ) — the annualized volatility of the portfolio’s returns; measures how wildly returns fluctuate

Annualizing standard deviation from daily returns: Annual σ = Daily σ × √252 (252 trading days per year)

Interpreting the Sharpe Ratio:

• Below 0: Portfolio returns less than the risk-free rate — losing money on a risk-adjusted basis
• 0.0–0.5: Poor
• 0.5–1.0: Acceptable
• 1.0–2.0: Good — institutional benchmarks typically target this range
• 2.0–3.0: Very good (top-tier funds)
• Above 3.0: Exceptional (hedge funds rarely sustain this)

What each variable means:

• Excess return (Rp − Rf) — the return above what you could earn with zero risk; this is the “alpha” component
• Standard deviation — both upside and downside volatility are penalized equally; the Sortino Ratio, a close cousin, penalizes only downside deviation
• Annualization — always compare Sharpe ratios calculated on the same time frequency; mixing monthly and daily σ produces incomparable results

Worked example: Strategy annual return: 18% Risk-free rate (T-bill): 5% Annual standard deviation of returns: 12%

Sharpe Ratio = (18% − 5%) ÷ 12% = 13% ÷ 12% = 1.08

Interpretation: For every 1% of volatility accepted, the strategy earns 1.08% of excess return. This is a good result — comfortably above the 1.0 threshold used by most institutional allocators.

Limitation: The Sharpe Ratio assumes returns are normally distributed and penalizes all volatility equally. A strategy with large, consistent gains but occasional volatility may be penalized unfairly. Always use Sharpe alongside Sortino and max-drawdown metrics.