What is the Sharpe Ratio?

The Sharpe Ratio is one of the most widely used metrics in the world of finance to measure the performance of an investment in relation to its risk. It was developed by Nobel laureate William F. Sharpe.

In simple terms, the ratio tells you how much "extra" return you are getting for each unit of risk you take on.

How is it calculated?

The formula is as follows:

Sharpe Ratio = (Portfolio Return - Risk-Free Rate) / Portfolio Volatility

Where:

• Portfolio Return: The return your investment portfolio has generated over a specific period.
• Risk-Free Rate: The return of a theoretically "risk-free" investment, such as a stable country's Treasury Bills. It represents the minimum return an investor would expect.
• Portfolio Volatility: The standard deviation of the portfolio's returns. It measures how much prices fluctuate; in other words, it is the measure of risk.

How is it interpreted?

• Ratio > 1: Generally considered good. It means you are getting a higher return for the risk you are taking.
• Ratio < 1: Considered suboptimal. The return does not compensate for the level of risk.
• Negative Ratio: Means your portfolio's return is lower than the risk-free rate.

Important: The Sharpe Ratio is most useful for comparing different portfolios or strategies. A portfolio with a Sharpe Ratio of 1.5 is preferable to one with a ratio of 0.8, as it is generating more return for each point of risk.

By selecting "Maximize Sharpe" in our tool, the optimizer will look for the combination of assets that offers the best possible balance between profitability and volatility, based on historical data.