(ER[a] - RFR) * STD[b])/STD[b]
Risk Adjusted Performance In A Nutshell
Risk adjusted performance allows you to depict the return and the risk almost as two separate numbers. This type of data figure can be applied to securities, portfolios, and funds. If you are familiar with options, then you many know the Greeks that measure risk, and you can use those along with any other data point you may have.
Risk is an extremely important factor when choosing your next investment or building your first portfolio. Risk adjusted performance measures the risk that is associated with generating the return that is desired.
Closer Look at Risk Adjusted Performance
Risk boils down to an individual level and is hardly ever the same across the board. For example, if you are in your twenties, it may be in your best interest to take the risks and go after the larger returns. On the flip side, it may not be the best to take on risk if you’re sixty years old and retiring soon.
It is also important before you invest in a fund to measure their risks against the benchmark and what the fund is returning. For index funds, you should typically see the same across the board, but for sector specific, it may not be the same. Take the time to read through the prospectus of each fund you are looking at because it can give you insight into the objectives of the fund, which you want to ensure line up with your investment objectives.
Lastly, you want to look at the performance of the fund because that it what we all really care about in the end. Take a look at the longer time frame because people typically invest in a fund as long term investments. With all of that said, this is where you can implement the risk adjusted performance statistic.
Just like any new investing tool, be sure to test it out and test it on a demo account first to see if it fits your current investing style. This may not be for everyone, but knowing how to implement it can be beneficial for other endeavors down the road. Join an investing community so you can bounce ideas off of them and see how other people are using the same tool. Risk is important and performance is important, using risk adjust performance can help combine those into a number suitable for comparing against others.