The Sharpe Ratio is a measure of risk-adjusted performance that compares the return of an investment to its volatility. It is calculated as the excess return (or risk premium) per unit of volatility.
A higher Sharpe Ratio indicates a more desirable risk-adjusted return.
The Sharpe Ratio is commonly used to evaluate the performance of investment portfolios, mutual funds, and other financial instruments. A good Sharpe Ratio is generally considered to be higher than 1, and a ratio greater than 1 is considered very good.
The higher the Sharpe ratio, the better the risk-adjusted performance of the investment.
- A ratio greater than 1 is considered good;
- A ratio greater than 2 is considered very good; and
- A ratio greater than 3 is considered excellent!
However, it's important to note that a higher Sharpe Ratio is not always better. It depends on your investment objectives and risk tolerance. It's also important to compare Sharpe Ratio across same type of investments and with similar characteristics. It is not fair to compare the Sharpe Ratio of a stock to the one of a bond, as the volatility and returns are different.
It's also important to remember that a high Sharpe Ratio doesn't necessarily mean an investment has a low risk. A high Sharpe ratio can be achieved by taking on more risk, therefore the higher the Sharpe Ratio, the more risk you are taking on.