Risk-adjusted return.

In plain English

Risk-adjusted return divides performance by some measure of variability so two investments with different volatility can be compared on the same footing. The Sharpe ratio uses total volatility, the Sortino ratio uses only downside movement, and other versions use market exposure or maximum decline. All of them ask the same question: how much movement was endured for each unit of return delivered. A high raw return achieved through a concentrated or heavily borrowed position can score worse than a steadier, smaller return. The comparison only holds if both measures cover the same time period and the same risk-free reference.

01Why it matters

Two funds can both report 12 percent while one delivered it smoothly and the other through swings a real person would have sold into, and only the adjusted figure shows that difference.

02The math, step by step

Fund A returns 12 percent with 20 percent volatility. Fund B returns 9 percent with 10 percent volatility. Against a 3 percent risk-free rate, A scores (12 minus 3) divided by 20, or 0.45. B scores (9 minus 3) divided by 10, or 0.60. The lower-returning fund earned more per unit of risk.

Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.

03What this is NOT

04Receipts

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