So you just learned that thanks to risk, not all returns are created equal 🏦

The Sharpe Ratio is the most popular number investors use to measure risk-adjusted return 🔍

💡 Sharpe Ratio = (investment return ➖ risk-free rate) ➗ (standard deviation of investment return)

Whoa, that's a lot of jargon! 🤯 Let's break it down:

💡 Investment return = how much money the investment made 💰

It includes price changes and any dividends or interest payments.

💡 Risk Free Rate = the return you could get from a "zero risk" investment, like a government bond 🏛️

As of April 2024, the Risk Free Rate is roughly 4.6%, although it changes over time.

💡 Standard Deviation of Investment Return = how much the investment's returns bounce around 📈📉

The more volatile the investment's returns are, the higher the standard deviation.

Let's say you're calculating Nvidia's Sharpe Ratio for the last year.

💡 Just like how returns are measured over a period of time, the Sharpe Ratio is too, so over different time periods an investment can have different Sharpe Ratios!

Nvidia's investment return was a whopping ~200% in the last year, and the risk-free rate was ~4% ✏️

Over the past 5 years, Nvidia's standard deviation of returns was 45% 📄

So, let's plug these numbers into our formula: (investment return ➖ risk-free rate) ➗ (standard deviation of investment return)

200% - 4% is 196% ✅

And 196% ➗ 45% = 4.36 💪

In this example, Nvidia's Sharpe Ratio is 4.36, which is incredibly high! 🧮

Meanwhile, let’s say Microsoft’s Sharpe Ratio was 1.85 over the same period 🤔

So in the last year, Nvidia had a higher Sharpe ratio than Microsoft 🥳

This means that based on Sharpe Ratio, Nvidia had a higher risk-adjusted return 💪