Sharpe Ratio

Really useful metric to compare an investment’s return with its risk.

Resources

• https://www.youtube.com/watch?v=9HD6xo2iO1g
  • Blog version https://www.reddit.com/r/quant/comments/pe7wyt/introducing_sharpe_ratios_why_investing_is_not/
• https://www.investopedia.com/terms/s/sharperatio.asp

$$\text{Sharpe}=\frac{\mathbb{E}[R_p-R_f]}{{\sigma }_p}$$

where

• $R_p$ is the return of the portfolio
• $R_f$ is the risk-free rate
• ${\sigma }_p$ is the standard deviation of the portfolio’s excess return

For annualized, we multiply by $\sqrt{252}$.

What are reasonable numbers?

• The trailing ~20 year Sharpe of SPY (an ETF that tracks US large caps) is around 0.45. We want to at least beat that.
• Warren Buffet has a long-term Sharpe of around 0.75
• Good hedge funds have Sharpes in the 1-2 range
• Excellent ones will target long-term Sharpes of 2-4

So you should aim to get 2+ sharpe ratio.

Related

• Sortino Ratio