Why Every Investor Needs to Know About Sharpe Ratio

December 1, 20238 min read
Why Every Investor Needs to Know About Sharpe Ratio
Share on facebookShare on TwitterShare on Linkedin

Key Takeaways

  • The Sharpe ratio basically allows investors to assess an investment’s risk-adjusted returns.
  • In terms of risk-adjusted returns, the higher the ratio, the better the investment.
  • A Sharpe ratio limitation is that normal distributions do not reflect how financial markets actually operate, in that investment returns – at least over the short term – are not normally distributed due to market volatility.

Investors that seek to maximize returns and minimize risk would do well to understand the Sharpe ratio, which helps investors assess an investment’s return relative to the risk involved. The tool’s calculation may be based on forecast or historical returns. But what is the Sharpe ratio? Here is that and more.

What is Sharpe Ratio?

Named for economist William Sharpe, the Sharpe ratio has to do with risk-adjusted returns. It is a way to gauge an investment’s performance that folds in risk – specifically, the additional risk necessary for higher returns. Thus, the ratio allows investors to assess an investment’s risk-adjusted returns.

While investments can be evaluated exclusively relative to their projected returns, investors get a better understanding of their investment when they understand the level of risk they have taken or are about to take.

Also known as the Sharpe index, the ratio can be utilized to assess a single security or an entire investment portfolio. Either way, in terms of risk-adjusted returns, the higher the ratio, the better the investment.

By sizing up an investment’s expected return to the additional risk – relative to a minimally risky asset such as U.S. Treasury securities – the Sharpe ratio provides investors with a clear view of whether loftier returns are sufficiently rewarding them for assuming such extra risk.

How Does the Sharpe Ratio Work?

Investors generally aim for two objectives that are often at odds: the highest returns possible and minimal risk.  Where the Sharpe ratio can help is apprising the investor of their risk-adjusted returns.

Whether it is employed to measure past performance or anticipated future performance, the ratio can help investors learn about their returns: are they due to savvy decisions or from assuming excessive debt? If they are due to too much debt, investors could lose uncomfortable amounts when market conditions change.

The Sharpe ratio helps by providing investors with a numeral that tells them their risk-adjusted returns.  

How is Sharpe Ratio Calculated?

The Sharpe ratio is calculated by subtracted the risk-free rate from the holdings’ rate of return, frequently utilizing U.S. Treasury bond returns as a proxy for the risk-free return rate. Subsequently, the result is divided by the standard deviation of the portfolio’s excess return.

Sharpe Ratio = Rp – Rf


Standard Deviation of the portfolio’s Excess Returns (x) 


  • Rp is the expected return on whatever asset or portfolio is being measured
  • Rf is the risk-free rate, which is commonly a U.S. Treasury bill that is short of maturity. However, some financial experts contend that the Treasury that is used should be of similar duration.
  • Standard deviation (x) is an assessment of risk that is based on volatility. All things being equal, the lower the standard deviation, the less risk that is involved and the lower the Sharpe ratio.
  • The market risk premium is part of the formula that is represented by Rp-Rf and is the excess return above the risk-free rate. 

The ratio should provide investors with an unambiguous picture of risk versus return, demonstrating the amount of return is gained from the extra risk. Relative to the risk taken on a security or portfolio, the higher the ratio, the greater the investment return.

For example, portfolio A is expected to return 14% over the next year, while portfolio B, over the same period, is expected to return 11%. Without factoring in risk, portfolio A is obviously the best option.

The picture looks a bit different when risk is considered, as the Sharpe ratio provides a more comprehensive look at investments. Here, portfolio A presents an 8% standard deviation (additional risk) while portfolio B’s standard deviation is just 4%. Meanwhile, the risk-free rate is 3%, which is the yield for a medium-term U.S. Treasury security.

Here, then, is the Sharpe ratio for each portfolio:

  1. Portfolio A: (14 – 3) / 8 = 1.38
  2. Portfolio B: (11 – 3) / 4 = 2

So, after factoring in the volatility inherent in portfolio A, the Sharpe ratio of those holdings is less than portfolio B’s ratio. This means that, with a ratio of 2, portfolio B offers the best return on a risk-adjusted basis.

In general, financial experts consider a Sharpe ratio of two as good, while one that is between two and three is very good. A result over three is deemed excellent.

Components of the Sharpe Ratio

The major components of the Sharpe ratio include:

  • Return. In the calculation, return is the amount an asset yields. If normally distributed, the measured returns can be daily, weekly, monthly, or yearly. An issue here is that not all asset returns are normally distributed.
  • Risk-free rate. The risk-free rate employed in the Sharpe ratio’s calculation is usually either U.S. Treasury bills or the rate for cash. It is used to gauge whether the investor is appropriately compensated for the extra risk assumed. Note that while the T-bill has the least volatility, some contend that the security should equal the comparable investment’s duration.
  • Standard deviation. Standard deviation is an assessment of the variability of an investment return as it relates to the investment’s mean return for the time period being measured. It reveals an investment return’s volatility relative to its average return, with larger standard deviations indicating wider returns, and narrower standard deviations suggesting more concentrated returns.

Understanding Risk-Adjusted Return

Part of understanding risk-adjusted return means considering return and risk together and assessing investment performance.

The risk-adjusted return gauges the amount of profit an investment has made relative to how much risk the investment has represented during a certain time period. If multiple investments produced the same return over that period, the one with the lowest risk will generally have a better risk-adjusted return.

Interpreting Sharpe Ratio

The main point here is that a higher Sharpe ratio equals better risk-adjusted performance.  On the other hand, a negative Sharpe ratio signifies that the benchmark or risk-free rate exceeds the portfolio’s projected or historical return. If this is the case, the portfolio’s return is expected to be negative.

Limitations and Considerations

In investing, there is no perfect tool, and that includes the Sharpe ratio. Limitations and considerations include assumptions of normal distribution of returns, which are incorrect. The ratio assumes that returns are distributed normally on a curve. In such a distribution, the majority of returns are lumped around the mean and fewer returns are discovered in the curve’s tail.

The rub is that normal distributions do not reflect how financial markets actually operate, in that investment returns – at least over the short term – are not normally distributed due to market volatility. The result is a standard of deviation that is not as effective as a gauge of risk.

There is also an issue having to do with leverage, which is debt taken on to heighten an investment’s prospective return. Employing leverage raises an investment’s risk level. A substantial increase in standard deviation will result in a significant decline in the Sharpe ratio, and consequently, bigger losses.

Another consideration is that the Sharpe ratio is sensitive to the time period it is taken. In other words, it is not independent of the time period over which it is evaluated. Returns for multiple periods are typically computed by factoring in compounding, which renders the relationship more complex. 

For periods longer than a year, it is common to annualize data before computing a Sharpe ratio. In turn, this can provide helpful comparisons among strategies, even if forecasts are originally stated in terms of differing measurement periods.

Also, note that because the Sharpe ratio is crafted to analyze investments over the long term, it is not particularly useful to short-term traders.

Rise above Volatility

Diversify beyond the stock market with Yieldstreet.

Calculating Sharpe Ratio in Alternative Investments

Beyond securities such as stocks and bonds, investors can use Sharpe ratio to evaluate the risk-adjusted performance of investments or strategies in alternative investments – those with low correlation to public markets.

These investments, which include asset classes such as real estate, art, and structured notes, can potentially offer steady passive income, a hedge against inflation, and lower volatility. Such investments can also serve to diversify investment holdings. Crafting a portfolio with varying assets that have different expected risks and returns is a critical element of long-term successful investing. 

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Learn more about the ways Yieldstreet can help diversify and grow portfolios.


Despite its limitations, the Sharpe ratio can give investors a clearer view of risk for large, liquid, and diversified investments. In other words, it can come in handy in terms of measuring invest returns and risk. For some other investments, such as hedge funds, it is recommended that the ratio be used along with other risk-and-return tools.

Note that the metric can also be used with alternative investments, which also serve to diversify holdings, which can mitigate over portfolio risk.

We believe our 10 alternative asset classes, track record across 470+ investments, third party reviews, and history of innovation makes Yieldstreet “The leading platform for private market investing,” as compared to other private market investment platforms.

1 Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections may not reflect actual future performance. All securities involve risk and may result in significant losses.

3 "Annual interest," "Annualized Return" or "Target Returns" represents a projected annual target rate of interest or annualized target return, and not returns or interest actually obtained by fund investors. “Term" represents the estimated term of the investment; the term of the fund is generally at the discretion of the fund’s manager, and may exceed the estimated term by a significant amount of time. Unless otherwise specified on the fund's offering page, target interest or returns are based on an analysis performed by Yieldstreet of the potential inflows and outflows related to the transactions in which the strategy or fund has engaged and/or is anticipated to engage in over the estimated term of the fund. There is no guarantee that targeted interest or returns will be realized or achieved or that an investment will be successful. Actual performance may deviate from these expectations materially, including due to market or economic factors, portfolio management decisions, modelling error, or other reasons.

4 Reflects the annualized distribution rate that is calculated by taking the most recent quarterly distribution approved by the Fund's Board of Directors and dividing it by prior quarter-end NAV and annualizing it. The Fund’s distribution may exceed its earnings. Therefore, a portion of the Fund’s distribution may be a return of the money you originally invested and represent a return of capital to you for tax purposes.

5 Represents the sum of the interest accrued in the statement period plus the interest paid in the statement period.

6 The internal rate of return ("IRR") represents an average net realized IRR with respect to all matured investments, excluding our Short Term Notes program, weighted by the investment size of each individual investment, made by private investment vehicles managed by YieldStreet Management, LLC from July 1, 2015 through and including July 18th, 2022, after deduction of management fees and all other expenses charged to investments.

7 Investors should carefully consider the investment objectives, risks, charges and expenses of the Yieldstreet Alternative Income Fund before investing. The prospectus for the Yieldstreet Alternative Income Fund contains this and other information about the Fund and can be obtained by emailing [email protected] or by referring to www.yieldstreetalternativeincomefund.com. The prospectus should be read carefully before investing in the Fund. Investments in the Fund are not bank deposits (and thus not insured by the FDIC or by any other federal governmental agency) and are not guaranteed by Yieldstreet or any other party.

8 This tool is for informational purposes only. You should not construe any information provided here as investment advice or a recommendation, endorsement or solicitation to buy any securities offered on Yieldstreet. Yieldstreet is not a fiduciary by virtue of any person's use of or access to this tool. The information provided here is of a general nature and does not address the circumstances of any particular individual or entity. You alone assume the sole responsibility of evaluating the merits and risks associated with the use of this information before making any decisions based on such information.

9 Statistics as of the most recent month end.

300 Park Avenue 15th Floor, New York, NY 10022


No communication by YieldStreet Inc. or any of its affiliates (collectively, “Yieldstreet™”), through this website or any other medium, should be construed or is intended to be a recommendation to purchase, sell or hold any security or otherwise to be investment, tax, financial, accounting, legal, regulatory or compliance advice, except for specific investment advice that may be provided by YieldStreet Management, LLC pursuant to a written advisory agreement between such entity and the recipient. Nothing on this website is intended as an offer to extend credit, an offer to purchase or sell securities or a solicitation of any securities transaction.

Any financial projections or returns shown on the website are estimated predictions of performance only, are hypothetical, are not based on actual investment results and are not guarantees of future results. Estimated projections do not represent or guarantee the actual results of any transaction, and no representation is made that any transaction will, or is likely to, achieve results or profits similar to those shown. In addition, other financial metrics and calculations shown on the website (including amounts of principal and interest repaid) have not been independently verified or audited and may differ from the actual financial metrics and calculations for any investment, which are contained in the investors’ portfolios. Any investment information contained herein has been secured from sources that Yieldstreet believes are reliable, but we make no representations or warranties as to the accuracy of such information and accept no liability therefore.

Private placement investments are NOT bank deposits (and thus NOT insured by the FDIC or by any other federal governmental agency), are NOT guaranteed by Yieldstreet or any other party, and MAY lose value. Neither the Securities and Exchange Commission nor any federal or state securities commission or regulatory authority has recommended or approved any investment or the accuracy or completeness of any of the information or materials provided by or through the website. Investors must be able to afford the loss of their entire investment.

Investments in private placements are speculative and involve a high degree of risk and those investors who cannot afford to lose their entire investment should not invest. Additionally, investors may receive illiquid and/or restricted securities that may be subject to holding period requirements and/or liquidity concerns. Investments in private placements are highly illiquid and those investors who cannot hold an investment for the long term (at least 5-7 years) should not invest.

Alternative investments should only be part of your overall investment portfolio. Further, the alternative investment portion of your portfolio should include a balanced portfolio of different alternative investments.

Articles or information from third-party media outside of this domain may discuss Yieldstreet or relate to information contained herein, but Yieldstreet does not approve and is not responsible for such content. Hyperlinks to third-party sites, or reproduction of third-party articles, do not constitute an approval or endorsement by Yieldstreet of the linked or reproduced content.

Investing in securities (the "Securities") listed on Yieldstreet™ pose risks, including but not limited to credit risk, interest rate risk, and the risk of losing some or all of the money you invest. Before investing you should: (1) conduct your own investigation and analysis; (2) carefully consider the investment and all related charges, expenses, uncertainties and risks, including all uncertainties and risks described in offering materials; and (3) consult with your own investment, tax, financial and legal advisors. Such Securities are only suitable for accredited investors who understand and are willing and able to accept the high risks associated with private investments.

Investing in private placements requires long-term commitments, the ability to afford to lose the entire investment, and low liquidity needs. This website provides preliminary and general information about the Securities and is intended for initial reference purposes only. It does not summarize or compile all the applicable information. This website does not constitute an offer to sell or buy any securities. No offer or sale of any Securities will occur without the delivery of confidential offering materials and related documents. This information contained herein is qualified by and subject to more detailed information in the applicable offering materials. Yieldstreet™ is not registered as a broker-dealer. Yieldstreet™ does not make any representation or warranty to any prospective investor regarding the legality of an investment in any Yieldstreet Securities.

YieldStreet Inc. is the direct owner of Yieldstreet Management, LLC, which is an SEC-registered investment adviser that manages the Yieldstreet funds and provides investment advice to the Yieldstreet funds, and in certain cases, to retail investors. RealCadre LLC is also indirectly owned by Yieldstreet Inc. RealCadre LLC is a broker-dealer registered with the Securities and Exchange Commission (“SEC”) and a member of the Financial Industry Regulatory Authority (“FINRA”) and the Securities Investor Protection Corporation (“SIPC”). Information on all FINRA registered broker-dealers can be found on FINRA’s BrokerCheck. Despite its affiliation with Yieldstreet Management, LLC, RealCadre LLC has no role in the investment advisory services received by YieldStreet clients or the management or distribution of the Yieldstreet funds or other securities offered on our through Yieldstreet and its personnel. RealCadre LLC does not solicit, sell, recommend, or place interests in the Yieldstreet funds.

Yieldstreet is not a bank. Certain services are offered through Synapse Financial Technologies, Inc. and its affiliates (collectively, “Synapse”) as well as certain third-party financial services partners. Synapse is not a bank and is not affiliated with Yieldstreet. Bank accounts are established by Evolve Bank & Trust. Brokerage accounts and cash management programs are provided through Synapse Brokerage LLC (“Synapse Brokerage”), an SEC-registered broker-dealer and member of FINRA and SIPC. Additional information about Synapse Brokerage can be found on FINRA’s BrokerCheck. By participating in a Synapse cash management program, you acknowledge receipt of and accept Synapse’s Terms of Service, Privacy Policy, and the applicable disclosures and agreements available in Synapse’s Disclosure Library.

Investment advisory services are only provided to clients of YieldStreet Management, LLC, an investment advisor registered with the Securities and Exchange Commission, pursuant to a written advisory agreement.

Our site uses a third party service to match browser cookies to your mailing address. We then use another company to send special offers through the mail on our behalf. Our company never receives or stores any of this information and our third parties do not provide or sell this information to any other company or service.

Read full disclosure