💡As a reminder, Return = potential profit or losses on an investment

But the problem with return is that it doesn't capture the risk you took to make that investment in the first place!

Say hello to. . .

💡 Risk-adjusted return = return that considers how risky an investment is

Let’s say both Stock A and Stock B have 10% annual returns 🤔

But, Stock A was significantly riskier than Stock B, and had a much higher Beta value.

This would mean that Stock B has a higher risk-adjusted return 💪

In general you'd want to pick Stock B over Stock A because it performed just as well while being less risky!

So, higher risk-adjusted return = more potential profit given the amount of risk taken 🥳

Lower risk-adjusted return = less potential profit given the amount of risk taken 😔

Let's look at another more extreme example:

A mysterious man asks you to flip 2 coins, one is Red and one is Blue 🪙🪙

For the Red coin, if it comes up Heads, you get $1, and if it comes up Tails, you get nothing 📦

For the Blue coin, if it comes up Heads, you'd get $2, but if it comes up Tails, you DIE 💀

Now you flip both of them, and luckily both coins come up Heads -- you collect your $1 from the Red coin and $2 from the Blue coin and make it out alive 😌

Even though you made a higher return from the Blue coin, you literally risked your life for it, and you risked nothing for Red.

So, you'd probably say the Red coin had a better risk-adjusted return than the Blue coin 👍

The risk associated with stocks and investing won't result in death, but hopefully that helps illustrate why risk-adjusted return is important to understand as an investor 🤓

Because there are different ways to measure risk, there isn't a single, perfect way to calculate risk-adjusted return 📚

But there are several popular ways people estimate it, and next, we'll introduce you to 3 of them!