What is the Sharpe Ratio and how do I compare it across investments?

What is the Sharpe Ratio and how do I compare it across investments?

The Sharpe Ratio measures the risk-adjusted return of an investment. To compare it, look at the ratios of different investments; a higher Sharpe Ratio indicates better risk-adjusted performance.

Can you give me an example of how to calculate it?

Sure! The formula is (Return of the investment - Risk-free rate) / Standard deviation of the investment's return. For example, if an investment has a return of 10%, a risk-free rate of 2%, and a standard deviation of 5%, the Sharpe Ratio would be (10% - 2%) / 5% = 1.6.

How do I interpret the Sharpe Ratio values?

A Sharpe Ratio less than 1 indicates that the investment may not be worth the risk, while a ratio above 1 is considered acceptable. Ratios above 2 are excellent.

What are some limitations of the Sharpe Ratio?

Some limitations include its reliance on historical data, which may not predict future performance, and it assumes returns are normally distributed.