Quick answer
The Sharpe ratio is the average return of an investment above a benchmark, usually a riskless rate, divided by the standard deviation of that extra return [1]. Higher means more return per unit of volatility over the period measured.
#How is the Sharpe ratio calculated?
William F. Sharpe introduced the measure in 1966 as the "reward-to-variability" ratio for mutual funds [1]. In its common form, the benchmark is a riskless security, so the numerator is the fund's excess return over a riskless rate of interest [1]. The denominator is the standard deviation of that excess return.
Which rate counts as riskless is a choice the person doing the calculation makes and should state. In the US, one short-term, government-backed option is a Treasury bill: Investor.gov describes Treasury bills as short-term securities maturing in a few days to 52 weeks, backed by the full faith and credit of the U.S. government [2].
Worked example
Comparing two funds
Over the same period, Fund X averaged 9% a year with a standard deviation of 15%. Fund Y averaged 7% with a standard deviation of 8%. The riskless rate averaged 3%. For simplicity, the funds' standard deviations stand in for the standard deviation of their excess returns.
- Fund X: (9% − 3%) ÷ 15%
- 0.40
- Fund Y: (7% − 3%) ÷ 8%
- 0.50
- Annualizing a monthly ratio of 0.12 (0.12 × √12)
- about 0.42
Fund X earned more, but Fund Y earned more per unit of volatility. The Sharpe ratio highlights that trade-off.
Hypothetical figures calculated in code. Past ratios do not predict future results.
| Part | Meaning |
|---|---|
| Return | The investment's return over each period |
| Riskless rate | Return on a riskless security over the same period |
| Excess return | Return minus the riskless rate |
| Standard deviation | How much the excess return varied |
| Sharpe ratio | Average excess return ÷ its standard deviation |
#What are the limits of the Sharpe ratio?
- It depends on the period. Sharpe notes that the ratio changes with the measurement interval; annualizing, by multiplying by the square root of the number of periods per year, makes figures comparable [1].
- It ignores correlation. Sharpe points out that the ratio does not take correlations into account, so it cannot tell you how a fund fits with what you already own [1].
- It inherits standard deviation's blind spots. Upside and downside swings count the same; see standard deviation.
#When is the Sharpe ratio useful for a beginner?
Mostly for comparing similar funds over the same period, for example two broad stock funds. It is less useful for comparing very different assets, and it should sit alongside costs, holdings and your own risk tolerance.
Related terms
Frequently asked questions
What is a good Sharpe ratio?
There is no universal cutoff. Ratios vary by period, asset type and data frequency, so compare funds measured the same way over the same time span.
Can a Sharpe ratio be negative?
Yes. If the investment returned less than the riskless rate over the period, the excess return and the ratio are negative.
Sources
Grade A = primary source (regulator, government agency, official rulebook or the index provider's own documents). Numbers in brackets in the text point here.
- William F. Sharpe, Stanford University. The Sharpe Ratio (The Journal of Portfolio Management, Fall 1994) (1994). Accessed 2026-10-03.B
- U.S. SEC — Investor.gov. Bonds (2026). Accessed 2026-10-03.A
This page is general education, not personal financial, tax or legal advice. Figures in worked examples are hypothetical and calculated before taxes and fees unless stated. Rules and limits change; check the linked primary sources for the current version. How we check every page.
