Sharpe ratio

The Sharpe ratio measures a portfolio's risk-adjusted return by dividing its excess return above the risk-free rate by its total standard deviation. A higher ratio means more return is earned per unit of total risk borne.

ByHoang TruongUpdated July 2, 2026

FrameworkRisk-adjusted performance

See it move

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Portfolio A returns 12 percent with a standard deviation of 15 percent, giving a Sharpe ratio of (12 minus 3) divided by 15, or 0.60. Portfolio B returns only 9 percent but with a standard deviation of just 6 percent, giving a Sharpe ratio of (9 minus 3) divided by 6, or 1.00. With a risk-free rate of 3 percent, Portfolio B is the more efficient converter of risk into return despite its lower return.

Where it fits

TopicRisk, Return & the CAPMAdvancedSubjectCorporate FinanceAdvanced

The formula

LaTeX

S = \frac{R_p - R_f}{\sigma_p}

Variables

$R_{p}$: Portfolio return over the measurement period
$R_{f}$: Risk-free rate over the same period
$σ_{p}$: Standard deviation of portfolio returns (total risk)

A higher Sharpe ratio means more excess return earned per unit of total risk. Because it uses total standard deviation rather than beta, it is suitable for comparing fully diversified portfolios rather than individual securities.

Check yourself

PracticeCORE

Portfolio X earned 14% with a standard deviation of 20%. Portfolio Y earned 10% with a standard deviation of 8%. The risk-free rate during the period was 2%. Which portfolio delivered the superior risk-adjusted return, and why?

Select an answer to check your understanding.