What is a good Sharpe ratio? Meaning, formula and benchmarks

The Sharpe ratio measures how much return an investment earned for each unit of risk it took. Two investments can both return 10 % a year; the one that got there with smaller swings has the higher Sharpe ratio — and was the better deal.

It was developed by Nobel laureate William F. Sharpe in 1966 and is the most widely used measure of risk-adjusted return in finance.

The Sharpe ratio formula

• Return — usually the average annual return.
• Risk-free rate — what you could earn without risk, typically short-term government bills (T-bills).
• Volatility — the annualised standard deviation of returns.

Example: a portfolio returns 9 % a year, T-bills pay 3 %, and the portfolio's volatility is 12 %. Sharpe ratio = (9 − 3) ÷ 12 = 0.5. For every percentage point of volatility you accepted, you earned half a percentage point of extra return over cash.

What is a good Sharpe ratio?

These ranges apply to long periods of real or carefully backtested data. Over one or two years, Sharpe ratios of 2 or 3 are common and meaningless; they usually say more about a calm market than about skill.

The Sharpe ratio of the S&P 500

Since 1993 the S&P 500 (total return) has had a Sharpe ratio of about 0.51. That is the benchmark most strategies are measured against: a long-run Sharpe ratio clearly above 0.5 with similar or smaller drawdowns is a genuine improvement.

Across the 30 markets in the Research Terminal, buy-and-hold Sharpe ratios range from below zero (the euro against the dollar) to around 1.0 (a few mega-cap tech stocks and Solana, over much shorter histories). Gold and the S&P 500 sit around 0.5; long-term Treasuries, oil and the dollar below 0.2.

How to interpret the Sharpe ratio

• Compare like with like. Compare Sharpe ratios over the same period and with the same risk-free rate. A Sharpe ratio from 2009–2021, a long bull market, is not comparable with one that includes 2000–02 and 2008.
• Higher is better — but check the other two numbers. A high Sharpe ratio with a deep max drawdown can still be unbearable to hold. Always read it together with return per year (CAGR) and the max drawdown.
• Leverage does not change it. Doubling a position doubles both return above cash and volatility; the Sharpe ratio stays the same. That is why professional investors use it to compare strategies before deciding how much risk to take.

The limits of the Sharpe ratio

• It treats upside and downside the same. Volatility from sharp rises counts as "risk" just like crashes. The Sortino ratio, which only counts downside volatility, addresses this.
• It assumes normal returns. Strategies with rare, large losses (selling options, for example) can show high Sharpe ratios right up to the moment they blow up.
• It is easy to overfit. Test enough variations of a strategy on past data and one will show a high Sharpe ratio by chance. A credible Sharpe ratio comes from a strategy that was fixed before being tested, over decades, and is then tracked live.

Sharpe ratio: strategy vs buy & hold

Every market in the Research Terminal shows three numbers side by side for its InvestWealth systematic strategy and for buy & hold: CAGR, Sharpe ratio and max drawdown. For the S&P 500 since 1993 the backtested strategy has a Sharpe ratio of about 0.73 against 0.51 for buy & hold — mainly because it stepped aside during most of the 2000–02 and 2008 bear markets.

Frequently asked questions