Almost all investments come with an element of risk but does this risk contribute to your return? Sharpe ratio is one of the calculations available to investors to assess returns on a risk-adjusted basis – be it for a single stock, or a basket of assets like a fund.
Subtract a risk-free rate (e.g. a treasury bond) from the fund’s return, then divide the result with the fund’s standard deviation and you arrive at a number. The sharpe ratio shows the excess return over the risk-free rate, in other words, the risk premium per unit. A higher figure shows better risk-adjusted performance.