Risk Adjusted Return

The risk-adjusted return of an asset or a portfolio is the return it provides adjusted for how risky it is. An asset with a superior risk-adjusted return is one that has the highest return for a given level of risk. Risk-adjusted return enables investors to compare the performance of low risk, low return investments to high risk, high return investments. Risk-adjusted return is calculated using the Sharpe ratio, a volatility-adjusted measure of return. To calculate risk-adjusted return, subtract the risk-free rate from the investment's return, then divide the resulting number by the standard deviation of the investment's return. The value of a risk-adjusted return lies in its ability to reveal whether an investment's returns are attributable to smart investing or excessive risk-taking. Risk-adjusted return is a useful tool for factoring volatility into investment decisions.