Sharpe Ratio.
A definition, in plain English — with the books that teach it.
What it means
The Sharpe Ratio measures how much excess return a portfolio earns per unit of total risk (standard deviation). It is calculated by subtracting the risk-free rate from the portfolio's return, then dividing by the portfolio's standard deviation. A higher Sharpe Ratio signals better risk-adjusted performance. The ratio is most useful when comparing two portfolios with similar strategies; it penalizes both upside and downside volatility equally, which is a limitation some analysts address with the Sortino Ratio.
Example
A fund returned 10% annualized with a standard deviation of 12%. The risk-free rate was 4%. Sharpe Ratio = (10% − 4%) / 12% = 0.50. A competing fund returning 8% with a standard deviation of 6% has a Sharpe of (8% − 4%) / 6% = 0.67 — better risk-adjusted performance despite the lower raw return.
