How to Calculate the Sharpe Ratio
Short answer. Subtract the risk-free rate from the portfolio’s return and divide by the standard deviation of the portfolio’s returns. A 10% return with a 2% risk-free rate and 12% volatility gives a Sharpe ratio of about 0.67, the excess return earned per unit of risk.
The formula
Sharpe ratio = (Rp - Rf) / Standard deviation of Rp
Step by step
- Pick a period. Use the same period for return and volatility, usually annual.
- Get the portfolio return Rp. Annualised return over that period.
- Get the risk-free rate Rf. For example a Treasury bill yield for the same period.
- Get the standard deviation. Annualised volatility of the portfolio’s returns.
- Compute. (Rp - Rf) divided by the standard deviation.
Worked example
Two funds compared
- Fund A: return 10%, volatility 12%, risk-free 2%: (10 - 2) / 12 = 0.67.
- Fund B: return 8%, volatility 6%: (8 - 2) / 6 = 1.00.
- Fund B earns less in absolute terms but more per unit of risk.
Common mistakes
- Mixing monthly returns with an annual risk-free rate.
- Using it on returns that are far from normally distributed.
- Comparing Sharpe ratios computed over different periods.
Frequently asked questions
What is a good Sharpe ratio?
Above 1 is often considered good, above 2 very good, but the number depends on the period and asset class.
Can the Sharpe ratio be negative?
Yes, when the return is below the risk-free rate.
What is the difference from the Sortino ratio?
Sortino divides by downside deviation only.
General education, not personal financial advice. Example figures are illustrative.