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Updated 2mo ago.
Updated 2mo ago.
The Sharpe ratio measures an investment's excess return above a risk-free asset (typically Treasury bills), divided by its volatility. It allows investments to be compared while accounting for the risk taken. A higher ratio indicates better risk-adjusted performance.
If VEQT.TO generates 10% per year with 15% volatility, and the risk-free rate is 4%, its Sharpe ratio is (10% - 4%) / 15% = 0.40. A tech ETF generating 14% but with 25% volatility would have a ratio of (14% - 4%) / 25% = 0.40 — identical. They have the same risk/return efficiency despite very different profiles.
The Sharpe ratio is useful for comparing ETFs with different risk profiles. A fund with 12% returns and a Sharpe ratio of 0.3 is actually less attractive than one with 9% returns but a Sharpe ratio of 0.6. However, the ratio is based on past data and assumes normally distributed returns — an imperfect assumption.