Interpreting the Sharpe Ratio
The relationship between risk and return is an essential concept in finance, which argues that riskier investments should compensate investors with higher returns and safer investments should not experience exorbitant price fluctuations.
When comparing the performance of two securities, funds or portfolios, investors must consider risk-adjusted returns to see if they are being adequately compensated for the risk they are assuming. The goal is to achieve the largest return per unit of risk.
William Sharpe devised the Sharpe ratio in 1966 to measure this risk/return relationship, and it has been one of the most-used investment ratios ever since. Here, we discuss how to calculate and interpret the Sharpe ratio.
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