Why are portfolios ranked by return alone without regard for risk? It's like ranking the best skydivers by how high they usually jump from rather than things like, "Do they have a parachute?", "Have they ever landed a jump before?".
Nathan Worden's avatar
This is a great point — would love to see something like the Sharp ratio be used to help address this.
Nathan Worden's avatar
@alejandro_r not a stupid question—

The Sharpe ratio adjusts a portfolio’s past performance—or expected future performance—for the excess risk that was taken by the investor.

The Sharp Ratio is derived by subtracting the risk-free rate from the return of the portfolio. (The risk-free rate could be a U.S. Treasury rate or yield, such as the one-year or two-year Treasury yield.)

Then you divide the result by the standard deviation of the portfolio’s excess return. The standard deviation helps to show how much the portfolio's return deviates from the expected return. The standard deviation also sheds light on the portfolio's volatility.

Subtracting the risk-free rate from the mean return allows an investor to better isolate the profits associated with risk-taking activities.
Brendan Barr's avatar
@bbarrOctober 14
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Great explanation, @nathanworden. I should also clarify that I don't mean to knock those who take a few bets, have good luck, and ride them. I would just like to have a top performers list (filtered?) that is more relevant to my risk-aware, longer-term style of investing.
Alejandro Rodriguez's avatar
This might be a stupid question, but what is a Sharp ratio?
Nathan Worden's avatar
100% agree with you @bbarr — investing is all about risk adjusted returns. Taking on too much risk over time ends you up back at square one in the long run.

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