Risk-Adjusted Return: Overview and Example

By Kristi Waterworth – Updated Sep 6, 2025 at 3:37 PM EST | Fact-checked by Frank Bass

Key Points

High risk-adjusted returns suggest efficient performance for the invested capital.
Low risk-adjusted returns indicate potentially suboptimal investments.
Comparing risk-adjusted returns helps select better-performing portfolios.

It's one thing for us to tell you that your risk tolerance matters and that you should consider it in your investing practices, but it's quite another to actually measure the outcomes of that. Risk-adjusted return is one way to do just that -- and tease out the level of risk from the returns you're earning. Read on to learn more.

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A blue sign that says Risk Ahead. — Image source: Getty Images.

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Risk-adjusted return formulas

The formulas for each of the common risk-adjust return ratios are all pretty simple, but you'll need additional information that speaks to the risks of your particular investment in order to perform the calculations.

Here are the formulas:

Sharpe Ratio = (Investment Return - Risk-Free Rate) / Standard Deviation of Investment

Sortino Ratio = (Investment Return - Risk-Free Rate) / Downside Deviation of Investment

Treynor Ratio = (Investment Return - Risk-Free Rate) / Beta of Investment

As you can see, these formulas are all pretty similar and use mostly the same information. The risk-free rate that's generally used is that of Treasuries, since they are some of the most risk-free assets available to typical investors. The deviations and betas will have to be calculated for each asset you consider.

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Why risk-adjusted return matters to investors

The more you know about what your invested money is doing, the better off you'll be – to a point. Calculating the risk-adjusted return isn't something every investor will take the time to do, and that's OK, but if you really want to know where your money is working the hardest for the risk it's taking, this is how you do it.

Risk-adjusted returns can tell you if you're taking some really big leaps for not much payoff. If you are, it just makes more sense to buy something a lot less challenging and with less risk involved. If you can buy an S&P 500 ETF that returns the same as a high-flying tech stock that's just launched its first and only product after the risk is considered, for the long term, you're probably better off going with the ETF. Could the stock take off and make you a fortune? Sure. But you could also lose everything, and if the return isn't there, why take the risk?

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About the Author

Kristi Waterworth has been a contributing real estate and financial expert at The Motley Fool, covering real estate, investing, and personal finance topics, since 2020. Kristi has been interviewed by various TV media outlets and podcasts for her real estate investing expertise – from residential real estate to digital real estate and everything in between. Kristi’s journalist career spans over 25 years, and she has written about real estate investing, homeownership, and home construction specifically for the last decade. She was also previously a licensed Realtor and general building contractor before the Great Recession and housing market collapse. She holds a bachelor’s degree in American history from Columbia College in Missouri.

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