What Is the Sharpe Ratio (and How to Interpret It)

The Sharpe ratio is one of the most widely used metrics to measure whether an investment compensates for the risk it takes on. It answers a simple question: how much extra return am I getting per unit of risk?

The formula

It's calculated as the portfolio's return minus the risk-free rate (what a riskless Treasury bond yields), divided by the volatility (the standard deviation of returns):

• Sharpe = (Return − Rf) / Volatility

The risk-free rate (Rf) is usually approximated with the 3-month U.S. Treasury bill. OjoAlTicker updates it automatically on login.

How to interpret it

• > 1 is considered good: the portfolio clearly returns more than the risk it takes on.
• 0 to 1 acceptable but could be improved.
• < 0 the risk-free asset (the bond) would have paid more, without the swings.

Its main limitation: it penalizes upside volatility just as much as downside volatility. To isolate only the "bad" risk (drawdowns), there's the Sortino ratio, which divides by downside volatility instead of total volatility.

In practice

You can see the historical Sharpe ratio for any index component on its ticker page, or calculate it for a full portfolio with the optimizer, which specifically searches for the weight combination that maximizes Sharpe for a given set of assets.