The Sharpe Ratio is used to help investors understand the return of an investment relative to its risk. This is often referred to as the risk-adjusted return.
It was developed by Nobel laureate William F. Sharpe and has been widely used at the pointy end of the funds management industry ever since. So why do you need to know about it? In short, to help you choose investments that deliver the best returns for the level of risk you are comfortable with.
Definition: The Sharpe Ratio looks at the average return above the risk-free rate of return, adjusted for the volatility of returns.
Let’s unpack that a bit.
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