What Is the Sharpe Ratio?

By Lee Samaha – Updated Jul 4, 2025 at 12:06 AM EST

Key Points

Sharpe ratio measures asset return adjusted for risk using excess return standard deviation.
Fund B's higher Sharpe ratio suggests better risk-adjusted returns despite lower average return.
Use the Sharpe ratio with other tools for a comprehensive evaluation of investment performance.

The Sharpe ratio is a measure used to gauge the return of an asset when adjusted for the risk taken onboard. The word "asset" encompasses a wide range of financial instruments, but the most common use of the Sharpe ratio is to compare funds and the performance of fund managers. You can use it in your investing to see how you match up with fund managers. Here's how to use the Sharpe ratio to improve how you allocate money.

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Treasury Bills (T-Bills)

A short-term debt issued and backed by the government, offering a low-risk investment with maturity typically under a year.

A fund with a higher Sharpe Ratio implies a relatively higher return for the risk taken on board than a fund with a lower Sharpe ratio.

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Data source: Author’s analysis

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Using the data and the Sharpe ratio equation above,

Fund A's Sharpe ratio = (10.6% – 4%)/17.4% = 0.38
Fund B's Sharpe ratio = (9.6% – 4%)/3.6% = 1.55

In other words, even though the average return of Fund A is higher than that of Fund B, its Sharpe ratio is much less due to variance around its results. According to the Sharpe Ratio methodology, investors are better compensated for the risk taken by the fund in Fund B, even though its average returns are lower over the period.

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About the Author

Lee Samaha is a contributing Stock Market Analyst at The Motley Fool covering industrials, electricals, energy, materials, transportation, and infrastructure stocks. Prior to The Motley Fool, Lee was a Civil Engineer and Investment Manager. He holds a Bachelor of Civil and Structural Engineering from Southampton University and a Certificate in Investment Management from Chartered Institute for Securities & Investment. Lee first cut his investing teeth on The Motley Fool bulletin boards (commonly referred to as the “Fool Boards,”) and he’s infinitely grateful to all of the investors he learned from in this powerful investing community.

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