Risk-Adjusted Return

Risk-Adjusted Return is a concept that refines an investment's return by the risk involved in producing that return. Risk-adjusted returns can be applied to individual securities and investment funds and portfolios.

Risk-Adjusted Return

Risk-Adjusted Return is a concept that refines an investment's return by the risk involved in producing that return. Risk-adjusted returns can be applied to individual securities and investment funds and portfolios.

 

Risk-Adjusted Return Formula

There are many methods for comparing one investment to another... Sharpe Ratio, Sortino Ratio, Alpha, etc.  But the average investor often has trouble relating to these types of figures.  To produce a number that is more intuitive for the average investor, the following formula can be used:



The actual average return is multiplied by the standard deviation of the actual returns of a benchmark (relevant index) and then divided by the standard deviation of actual returns. The result is a Risk-Adjusted Return that relates directly to published returnsr. A mutual fund's risk-adjusted return is what a fund would have returned if its level of risk, as measured by the standard deviation of returns, was the same as that of the benchmark index.

Explanation of Risk-Adjusted Return

Risk-Adjusted Return provides a simple means of comparing investments on a common basis, adjusted for risk.



Note that Risk-Adjusted Return is a backward looking calculation and does not say anything about the future performance of the investment.  Quite often, funds with the highest Risk-Adjusted Return over the previous measurement period, have poor Risk-Adjusted Returns over the next period.

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