Understanding Sortino and Sharpe Ratios: A Simple Guide with Examples

stock image of money growth

When investing, we all want good returns, but we also want to manage risk. Two key ratios help investors measure risk-adjusted returns: the Sharpe Ratio and the Sortino Ratio. These sound complicated, but don’t worry! We’ll break them down with simple explanations and examples.

What is the Sharpe Ratio?

The Sharpe Ratio helps investors understand how much return they’re getting for the risk they are taking. It is calculated as:

Sharpe Ratio = (Portfolio return — Risk free rate) / Portfolio volatility

• Portfolio Return: The return your investment generates.
• Risk-Free Rate: The return you would get from a risk-free investment (like a government bond).
• Standard Deviation: A measure of how much returns fluctuate (higher means riskier).

Imagine You Have Two Investment Options

Let’s say you have ₹1,00,000 to invest, and you are considering two different options:

1. Fixed Deposit (FD)

• Gives a guaranteed return of 6% per year.
• This is considered a risk-free investment because banks are reliable.
• So, the Risk-Free Rate =…