Sortino Ratio Formula & Calculator

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Sortino Ratio Formula

Are you interested in evaluating the risk-adjusted returns of your investment portfolio? One commonly used measure for this purpose is the Sortino Ratio.

The Sortino Ratio is similar to the Sharpe Ratio, but it only considers the downside risk of the portfolio, which is defined as the standard deviation of returns below a certain threshold (usually the risk-free rate). The formula for the Sortino Ratio is:

Where:

• Portfolio Return is the return of the investment portfolio.
• Risk-Free Rate is the rate of return on a risk-free asset, such as U.S. Treasury bills.
• Downside Deviation is the standard deviation of returns below the risk-free rate.

By using the Sortino Ratio, investors can better assess the risk-adjusted returns of their portfolios and make more informed investment decisions.

Sortino vs Sharpe

When evaluating the risk-adjusted returns of an investment portfolio, two commonly used measures are the Sharpe Ratio and the Sortino Ratio.

The Sharpe Ratio is a measure of excess return per unit of risk. It considers both the upside and downside risk of a portfolio, which is defined as the standard deviation of returns. The formula for the Sharpe Ratio is:

The Sortino Ratio, on the other hand, is a measure of excess return per unit of downside risk in a portfolio. It only considers the downside risk of a portfolio, which is defined as the standard deviation of returns below a certain threshold (usually the risk-free rate). The formula for the Sortino Ratio was discussed in the previous "Sortino Ratio Formula" section.

Both measures are important to consider when constructing a portfolio, but all else equal, investors may prefer a portfolio with a higher Sortino Ratio as it demonstrates higher risk-adjusted return potential. This is because a high Sharpe Ratio may indicate a portfolio generating excess returns by taking on significant overall risk, including tail risk, which leaves the portfolio more exposed to significant losses during market downturns.

By using the Sortino Ratio in addition to the Sharpe Ratio, investors can gain a more nuanced understanding of the risk profile of their portfolio and make more informed investment decisions.