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Difference Between Sharpe Ratio vs Sortino Ratio
If you are planning to invest your money, it is essential to track your investments so that you save the amount invested and the return on that amount. The Sharpe Ratio and the Sortino Ratio are the two most popular tools for monitoring investments.
Both help you understand if the returns you're getting are worth the risks. However, they measure risk differently, making them useful for different investors. Knowing the difference between the Sharpe ratio and the Sortino ratio can help you make better investment choices.
This article will reflect on these tools and their active usage to track your investment and its growth.
Table of Contents
What is the Sortino Ratio in Mutual Funds?
The Sortino ratio is a simple way to check the performance of a mutual fund relative to the downside risk. It has a better balancing risk and return function. For example, if a mutual fund has a Sortino ratio of 2, it compensates for the downside risk it takes. If it is one, then vice-vera applies.
It serves as a method for risk-averse investors to find matching funds for their investment goals while reducing the money that can be lost. The Sortino Ratio helps you see how safe a fund is while still giving you returns by focusing only on bad risks.
How To Calculate Sortino Ratio?
Knowing how to calculate the Sortino ratio helps you keep track of your investment effectively. Here is a formula given below to calculate the Sortino ratio:
Sortino Ratio = R – Rf / SD
Where,
R is the expected returns
Rf is the risk-free rate of returns
SD is the negative asset return's standard deviation
What is the Sharpe Ratio in Mutual Funds?
The Sharpe ratio helps the investor understand how well a mutual fund performs in comparison to the risks it takes. Thus, it measures the risk-adjusted returns of stocks and mutual funds plans. This makes it easier to see if the fund is giving good returns for the risks associated with it, both downside and upside risk.
This means the Sharpe ratio reveals how much return a fund provides for each unit of total risk. A more excellent Sharpe ratio implies the fund is good at handling risks and providing better returns. This ratio appeals to investors who love safety and portfolio growth. That is why this ratio would help make sharp investment decisions.
How To Calculate Sharpe Ratio?
Understanding the Sharpe ratio calculation helps you keep track of your investment effectively on your own. Here is a formula given below to calculate the Sharpe ratio:
Sharpe Ratio = (R(p)-R(f)) / StdDev Rx,
Where,
R(p) is the return on the investment.
R(f) is the return of a risk-free investment, such as a government bond or bank fixed deposit.
StdDev Rx is the standard deviation of the investment's returns.
What is the Difference Between Sharpe Ratio and Sortino Ratio?
Understanding the difference between the two ratios helps you make informed decisions. The table below explores the differences between Sharpe and Sortino Ratio to give a better understanding:
Advantages of Sharpe Ratio and Sortino Ratio
The Sharpe and Sortino ratios are widely used metrics for evaluating investment performance. Both are valuable tools and offer the following benefits:
Disadvantages of Sharpe Ratio and Sortino Ratio
The Sharpe and Sortino ratios rely on historical data and may not accurately predict future performance. They have certain drawbacks that individuals must consider, such as:
Which is Better: the Sharpe Ratio or the Sortino Ratio?
The choice depends on the individual's investment objectives, risk tolerance, and specific investment strategies.
1. Focus on Risk
A Sharpe ratio captures both positive and negative volatilities, generalizing the view of a risk-adjusted return. On the other hand, a Sortino ratio focuses solely on downside risk and is better for loss minimization.
2. Performance Evaluation
The Sharpe ratio is much better suited to assessing the overall investment performance because it adjusts the returns by the total risk. The Sortino ratio is a better view when the main goal is to minimize the downside risk.
3. Volatility Treatment
The Sharpe ratio treats all volatility equally, which may not appeal to investors who want to avoid adverse outcomes. The Sortino ratio penalizes only negative volatility, thus appealing more to those who avoid risk.
Disclaimer: The information provided on this website is for general informational purposes only and should not be construed as financial, investment, or legal advice. While we strive to provide accurate and up-to-date content, we do not guarantee the completeness, reliability, or suitability of the information for your specific needs.
We do not promote or endorse any financial product or service mentioned in these articles. Readers are advised to conduct their own research, consult with financial experts, and make informed decisions based on their unique financial circumstances. Any reliance you place on the information provided here is strictly at your own risk.
FAQs about Sharpe Ratio vs Sortino Ratio
Why is the Sortino ratio better for investors who worry about losses?
The Sortino Ratio considers only the downside risk, i.e., the volatility portion that creates losses. Thus, it is more beneficial for conservative investors.
How does the Sortino ratio only consider the harmful risk?
How do the Sharpe and Sortino Ratios impact portfolio strategies?
How does the Sortino ratio correct the Sharpe ratio's problem with downside risk?
Why do fund managers like showing the Sortino ratio?
Fund managers often use the Sortino ratio to showcase their downside risk management. Conservative investors also prefer this metric.
Can both the Sharpe and Sortino Ratios be used together for better insights?
How does a change in the risk-free rate affect the Sharpe and Sortino ratios?
What is a good Sharpe ratio?
What is a good Sortino ratio?
What is the difference between the Sharpe ratio and the Sortino ratio?
How to calculate the Sharpe ratio and Sortino ratio?
The Sharpe ratio is calculated as the difference between the portfolio return and the risk-free rate divided by the portfolio's excess return standard deviation.
Sharpe Ratio = (R(p)-R(f)) / StdDev Rx,
In contrast, in the Sortino ratio, the portfolio return is subtracted from the risk-free return, and this difference is divided by the downside deviation or negative volatility.
Sortino Ratio = R – Rf / SD
What are the advantages of the Sharpe and Sortino ratio?
One of the Sharpe ratio's merits is its simplicity and universal applicability in various investments. It provides a simple measure of risk-adjusted performance.
The key feature of the Sortino ratio is that it is a disciplined, risk-centric metric that explicitly focuses on downside risk or loss for the investor filtering it.
What are the disadvantages of the Sharpe and Sortino ratio?
The major drawback of the Sharpe ratio is that it similarly treats upside and downside volatility. Thus, it negatively penalizes any investment, generating substantial positive swings.
The limitation of this Sortino Ratio is its reliance on some targeted return, which might tend towards subjectivity and affect how such a ratio is staged.
When should the Sharpe ratio and Sortino ratio be used?
Other Important Articles about Mutual Funds
Disclaimer
- This is an informative article provided on 'as is' basis for awareness purpose only and not intended as a professional advice. The content of the article is derived from various open sources across the Internet. Digit Life Insurance is not promoting or recommending any aspect in the article or its correctness. Please verify the information and your requirement before taking any decisions.
- All the figures reflected in the article are for illustrative purposes. The premium for Coverage that one buys depends on various factors including customer requirements, eligibility, age, demography, insurance provider, product, coverage amount, term and other factors
- Tax Benefits, if applicable depend on the Tax Regime opted by the individual and the applicable tax provision. Please consult your Tax consultant before making any decision.
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