Understanding the Sharpe Ratio
The Sharpe ratio measures risk-adjusted return: how much excess return do you earn per unit of risk?
Interpretation Guide
| Sharpe | Quality |
|---|---|
| < 1 | Poor |
| 1 - 2 | Good |
| 2 - 3 | Very good |
| 3+ | Excellent |
Example
Portfolio: 12% return, 2% risk-free rate, 10% volatility:
Sharpe = (12 - 2) / 10 = 1.0
A Sharpe of 1.0 means you earn 1% excess return for every 1% of volatility. This is a decent result.