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Sharpe Ratio Calculator
Sharpe Ratio Calculator
What is Sharpe Ratio
The Sharpe Ratio is a widely used method for evaluating the performance of your investment portfolio. While it's quite similar to the Treynor Ratio, there’s a key distinction between the two.
Both ratios aim to measure the extra return you earn per unit of risk. In other words, they assess how much additional return you're generating for every unit of risk taken. However, the type of risk each ratio considers sets them apart.
The Treynor Ratio focuses solely on systematic risk—the market-related risk that cannot be diversified away. In contrast, the Sharpe Ratio takes a broader view by accounting for the total risk of the portfolio, which includes both systematic and unsystematic risk. This total risk is measured using the standard deviation of portfolio returns.
So, while the core idea remains the same evaluating return relative to risk—the Sharpe Ratio provides a more comprehensive picture of risk-adjusted performance.
What Does the Sharpe Ratio Actually Measure?
The Sharpe Ratio evaluates a portfolio's performance by considering both its return and the overall risk, including how well it’s diversified. Unlike some metrics that focus solely on systematic risk, the Sharpe Ratio doesn’t overlook poor diversification. Instead, it accounts for total risk, measured by standard deviation. This comprehensive approach makes the Sharpe Ratio a more appropriate and accurate measure of risk-adjusted performance.
Setting the Market Benchmark (Example)
Eg. Suppose that the 10 year annual return for S&P 500 (market portfolio) is 10% while the annual return of treasury bills (a good proxy for risk free rate) is 5%
The S&P 500 has a standard deviationbof 18% over a 10 year period, Determine Sharpe Ratio for following portfolio
• Manager X: Annual return = 14%, Portfolio Standard deviation = 0.11
• Manager Y: Annual return = 17%, Portfolio Standard deviation = 0.20
• Manager Z: Annual return = 19%, Portfolio Standard deviation = 0.27
Sol.
First we calculate the Sharpe ratio for the market
S(market) = (Rp - Rf)/σp
Rp = rate of portfolio = 10% = 10%/100% = 0.10
Rf = risk free rate = 5% = 5%/100% = 0.05
σp = standard deviation of portfolio = 18% = 18%/100% = 0.18
S(market) = (0.10 - 0.05)/0.18
S(market) = 0.278
This means that for every unit of risk, a return of 0.278 should be achieved. If your portfolio's Sharpe ratio falls below this benchmark, it indicates underperformance. In this context, 0.278 becomes the standard threshold for evaluating portfolio efficiency.
So
Calculating for Manager X
S(X) = (Rp - Rf)/σp
Rp = rate of portfolio = 14% = 14%/100% = 0.14
Rf = risk free rate = 5% = 5%/100% = 0.05
σp = standard deviation of portfolio = 0.11
S(X) = (0.14 - 0.05)/0.11
S(X) = 0.818
Calculating for Manager Y
S(Y) = (Rp - Rf)/σp
Rp = rate of portfolio = 17% = 17%/100% = 0.17
Rf = risk free rate = 5% = 5%/100% = 0.05
σp = standard deviation of portfolio = 0.20
S(Y) = (0.17 - 0.05)/0.20
S(Y) = 0.600
Calculating for Manager Z (and the Verdict)
S(Z) = (Rp - Rf)/σp
Rp = rate of portfolio = 19% = 19%/100% = 0.19
Rf = risk free rate = 5% = 5%/100% = 0.05
σp = standard deviation of portfolio = 0.27
S(Z) = (0.19 - 0.05)/0.27
S(Z) = 0.519
About the Author: Abhishek Lohar
B.Com Graduate and the Founder of Free Online Financial Calculator. I specialize in simplifying complex financial calculations and investment strategies. My mission is to ensure you can make confident financial decisions using our research-backed content and accurate calculators.
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Disclaimer: The information provided in this article is for educational purposes only and should not be considered financial advice. Please consult with a qualified professional before making any investment decisions.