What’s the best way to measure risk-adjusted returns?

December 5, 2022

The Sharpe ratio is widely considered to be the best way to measure risk-adjusted returns. It is a simple and intuitive measure that takes into account both the return of an investment and its risk. By subtracting the risk-free rate of return from the investment’s return and dividing that number by the investment’s standard deviation of returns, the Sharpe ratio provides a measure of how much excess return an investment generates for each unit of risk it takes on.

Other popular measures of risk-adjusted returns include the Treynor ratio, which is similar to the Sharpe ratio but uses beta instead of standard deviation as a measure of risk, and the Sortino ratio, which is similar to the Sharpe ratio but takes into account only downside risk. These measures can be useful in different situations, but the Sharpe ratio is generally considered the most widely applicable and widely used measure of risk-adjusted return.

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