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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

Sharpe=Annual return − Risk-free rateAnnual volatility
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%.

10%14% − 4%
25%volatility
0.4Sharpe ratio

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

Below 0.3the risk was poorly rewarded
0.3 - 1typical for stocks
Above 1very well rewarded (rare over the long run)

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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