What Is Sharpe?
Sharpe, or The Sharpe Ratio, is a widely used financial metric that measures the risk-adjusted return of an investment. It was developed by Nobel laureate William F. Sharpe in 1966.
The Sharpe ratio is calculated by subtracting the risk-free rate (such as the yield on a Treasury bond) from the return of the investment, and then dividing the result by the standard deviation of the investment’s returns. The formula is:
Sharpe Ratio = (Return of investment - Risk-free rate) / Standard deviation of investment’s returns
The Sharpe ratio helps investors evaluate an investment’s return in relation to the risk taken to achieve that return. A higher Sharpe ratio indicates that an investment has generated higher returns relative to the amount of risk taken, while a lower Sharpe ratio indicates the opposite.
Generally speaking, a Sharpe ratio above 1 is considered good, and a Sharpe ratio above 2 is considered excellent. However, what is considered good or excellent can vary depending on the context. For example, a lower Sharpe ratio may be acceptable for investments with lower risk or lower volatility, while a higher Sharpe ratio may be necessary for investments with higher risk or higher volatility.