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Sharpe Ratio

Updated on March 6, 2023

Sharpe ratio is a metric used for investment performance measurement. It is commonly used to estimate the average return from an investment after adjusting for its riskiness.

How is Sharpe Ratio calculated

Sharpe Ratio formula = (Average fund returns – Risk-free rate) / Standard deviation of fund returns

A mutual fund’s sharpe ratio can be calculated using the above-mentioned formula or by following these two steps –

1. Take off a mutual fund’s risk-free return from its average return
2. Divide the outcome (also called excess returns) by the fund return’s standard deviation

Importance of Sharpe Ratio

A sharpe ratio helps investors take a calculated investment decision after comparing two or more mutual fund options. It compares returns by levelling market volatility and risk element. Here are some of its other benefits:

a. Using this ratio, investors can compare a mutual fund against a benchmark performance.

b. It also allows investors to study the need for portfolio diversification.

c. Investors can also gauge the risk-return rate of an investment using the Sharpe ratio.