Compute the Sharpe ratio: excess return per unit of risk.
Sharpe ratio
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Excess return (over risk-free)
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Your breakdown
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What the Sharpe ratio is really measuring
A raw return number lies to you. A fund that returned 30% sounds spectacular until you learn it swung 60% in either direction to get there. The Sharpe ratio, built by Nobel laureate William Sharpe in 1966, strips out that noise. It asks a single sharp question: for every unit of risk you took on, how much return did you earn above what a riskless Treasury would have paid you? That last clause matters. If a T-bill pays 4.5% for doing nothing, only the return beyond 4.5% is genuine compensation for the volatility you stomached.
The two inputs that drive everything
The formula is excess return divided by standard deviation. Excess return is your portfolio's annual return minus the risk-free rate. Standard deviation is your portfolio's volatility, the statistical measure of how widely your monthly or annual returns scatter around their average. A 60/40 stock-bond portfolio historically runs around 9% to 10% volatility. An all-equity S&P 500 position runs closer to 15% to 18%. A single concentrated tech stock can easily exceed 40%. This calculator uses the 3-month Treasury yield as the default risk-free rate, which is the standard convention because it is the closest thing to a zero-risk return available to a US investor.
Running the numbers on a typical balanced portfolio
Take a portfolio that returned 10% over the year with 15% volatility, against a 4.5% risk-free rate. The excess return is 10% minus 4.5%, which is 5.50%. Divide that 5.50 by the 15 volatility and you get a Sharpe ratio of 0.367. Here is the calculation laid out.
A Sharpe of 0.367 is below par. The market did not reward you enough for the swings you accepted. The chart shows how the ratio climbs as volatility falls, holding the same 5.50% excess return.
Reading the result without fooling yourself
A useful rule of thumb: below 1 is subpar, 1 to 2 is acceptable, 2 to 3 is very good, and 3 or higher is excellent. But be suspicious of very high numbers. A Sharpe above 3 over a short window almost always means the measurement period was too short, the volatility was understated, or the strategy carries a hidden tail risk that has not shown up yet. Strategies that sell options or use heavy leverage often post gorgeous Sharpe ratios right up until a crash erases years of gains in a week. The calculator flags this directly when your input lands above 3.
Frequently asked questions
What is the difference between the Sharpe ratio and the Sortino ratio?
The Sharpe ratio penalizes all volatility, including the upside. If your portfolio shot up 40% one month, that counts as "risk" and drags the ratio down, which feels unfair. The Sortino ratio fixes this by only measuring downside deviation, the volatility of negative returns. For strategies with lumpy but mostly positive returns, Sortino often gives a fairer picture. Sharpe remains the industry default because it is simpler and easier to compare across funds.
Can the Sharpe ratio be negative, and what does that mean?
Yes. When your portfolio return falls below the risk-free rate, the excess return turns negative and so does the Sharpe ratio. It means you took on risk and were worse off than if you had simply parked the money in Treasury bills. A negative Sharpe is the clearest signal that a strategy is not earning its keep.
A practical word on how to use this number well. The single most common error is comparing Sharpe ratios computed over different time horizons or with different return frequencies, which is apples to oranges. A ratio built from daily returns is not directly comparable to one built from monthly or annual returns, because volatility scales with the square root of time, and annualizing requires multiplying by the square root of the number of periods in a year. Always compare ratios that were measured the same way over the same window. The second judgment call is the choice of risk-free rate itself: in a high-rate environment, the bar a risky asset must clear rises, and a strategy that looked brilliant when cash paid nearly nothing can suddenly look mediocre once Treasury bills yield 4% or 5%. That is not a flaw in the strategy, it is the Sharpe ratio doing its job and reminding you that the opportunity cost of taking risk has gone up. Use this tool to sanity-check a fund's marketing claims, to compare two of your own holdings on a level field, and to decide whether the bumps you are tolerating are actually buying you anything.