What Is Risk-Adjusted Return
A returns 12% a year, and so does B. But if A swung like a roller coaster while B was calm, should the two be viewed as the same performance? Risk-adjusted return answers 'no.'
Why return alone isn't enough
Return only tells you 'how much you made,' not 'how nerve-wracking' the process was. Even the same 12% return is a completely different experience for an investment that had to endure −50% along the way versus one that was tame at −10%.
Most people dislike risk (risk aversion). So for the same return, the less-volatile one is the better investment. What expresses this in numbers is the risk-adjusted return.
The most famous measure: the Sharpe ratio
The representative risk-adjusted return is the Sharpe ratio. The calculation is (return − risk-free rate) ÷ volatility (standard deviation).
The numerator is 'how much more you earned versus a safe deposit (excess return),' and the denominator is 'how much you swung in exchange (risk).' In other words, it measures 'how much excess return there is per unit of risk.' The higher the Sharpe ratio, the more return was generated for the same risk.
The metric changes depending on what you use to measure risk. Using total volatility gives the Sharpe ratio, using only downside (loss) volatility gives the Sortino ratio, and using the maximum drawdown gives the Calmar ratio.
The uses and limits of risk-adjusted return
Risk-adjusted return lets you fairly compare investments with different risks. It can sort out 'whether a high return is genuine skill or came from taking on large risk.'
That said, there are limits too. It's calculated with past data, so it doesn't guarantee the future, and volatility isn't all of risk. Rare, extreme losses (tail risk) are sometimes not well captured by standard deviation. So risk-adjusted return should be viewed together with metrics like maximum drawdown and loss duration.
常见问题
Q. What Sharpe ratio is considered good?
Generally people say 1 or above is decent and 2 or above is excellent, but it's not an absolute standard. It varies greatly by period, asset class, and market conditions, so it's meaningful when compared over the same period and under the same conditions.
Q. Is an investment with a high risk-adjusted return always good?
It's only a comparison tool, not an absolute judgment. Being a past-based calculation, it doesn't guarantee the future, and extreme loss risk may not be well reflected. You should view it comprehensively together with maximum drawdown and loss duration.
相关页面
📋 结果基于历史数据计算,过去的收益不代表未来的收益。
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