“I made +40% this year.” Well done — but at what risk? A raw return says nothing without its cost in risk. Three measures let you judge a performance honestly.
The Sharpe ratio: return per unit of risk
Above 1, the return/risk pair is considered good; above 2, excellent.
Two portfolios both up 12% are not worth the same: the one that achieved it with 10% volatility is far superior to the one that endured 30% of turbulence. The Sharpe ratio puts everyone on an equal footing.
Sortino: punishing only bad volatility
The Sharpe ratio's flaw: it penalises volatility on the upside as well as the downside. Yet nobody complains about a surge upwards. Sortino keeps only downside volatility, which is closer to what an investor actually feels.
Max drawdown: the most honest measure
Maximum drawdown measures the worst fall endured between a peak and the following trough. It averages nothing and smooths nothing: it shows the worst moment lived through. It is often the most useful figure, because it is the one that makes people panic-sell.
The cruel mathematics of losses
A 50% loss requires +100% to get back to breakeven. An 80% loss requires +400%. That is why limiting drawdown often matters more than maximising return.
In Earnnest
The portfolio's Risk tab computes Sharpe, annualised volatility and max drawdown over the period of your choice.
À retenir
- ✓A return without a measure of risk is incomplete information.
- ✓Sharpe = return/risk; Sortino = penalises only the downside; drawdown = the worst real pain.
- ✓Deep losses are asymmetric: −50% requires +100% to recover.