Sharpe ratio
A ratio that shows how much return an investment delivered per unit of risk taken.
In short
As of 8 October 2026The Sharpe ratio shows how much return an investment delivered per unit of risk. It takes the return minus the risk-free interest rate and divides the result by the volatility. The higher the value, the better the risk was rewarded. The ratio is based on past data and says nothing certain about the future.
The Sharpe ratio relates gains to swings. The formula: return minus the risk-free rate, divided by volatility. The higher the value, the more return you got per unit of risk.
This lets you compare two funds that earned similar amounts but fluctuated very differently. The return used is usually the average annual return, a figure like the CAGR. The ratio only looks backwards and treats upward and downward swings the same.
Example: fund A returned 8 % a year with 16 % volatility, fund B 7 % with 10 %. With a 2 % risk-free rate, A has a Sharpe ratio of 0.375 and B of 0.5, so B rewarded its risk better. Why spreading your money helps here is explained in the chapter on risk and diversification.
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As of 8 October 2026 · Educational content, not investment or tax advice.