Risk and return · updated October 21, 2026
What is the Sharpe ratio and how is it calculated
The Sharpe ratio shows how much return above a risk-free investment you got for each unit of volatility you sat through. It lets you compare two investments with different risks on the same scale.
The Sharpe ratio formula
- Annual return
- The stock's average yearly gain, dividends included.
- Risk-free rate
- The interest on short-term government bonds.
- Volatility
- How much the price moves in a year.
Worked example
A stock returned 14% a year, government bonds 4%, and volatility was 25%.
Another stock with 10% a year and 12% volatility would have a Sharpe of 0.5: it earned less, but with a calmer ride.
How to read the Sharpe ratio
Over the long run, the US market has had a Sharpe ratio of about 0.4-0.5.
When the Sharpe ratio can fool you
It treats ups and downs the same: a stock with big jumps upward is "punished" just like one that falls. The Sortino ratio fixes this.
Related terms
Questions about the Sharpe ratio
What is a good Sharpe ratio for a stock?
Above 0.5 over three years is good. Above 1 over several years is exceptional and rare.
These explanations are for information only. They are not a recommendation to buy or sell.
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