What is a risk-adjusted return, and which measure is commonly used?

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Multiple Choice

What is a risk-adjusted return, and which measure is commonly used?

Risk-adjusted return is about evaluating how much return you earn for each unit of risk you take. The most common way to measure this is the Sharpe ratio, which compares the portfolio’s excess return over a risk-free rate to its total volatility. In simple terms, you subtract the risk-free return from what you earned, then divide by how much the investment’s returns swung. This ratio tells you how efficiently a portfolio converts risk into higher returns—the higher the better. Other measures exist but focus on different kinds of risk. The Treynor ratio uses only systematic risk (beta) rather than total volatility, and the Sortino ratio uses downside risk instead of all volatility. Inflation adjustment would give you real returns, not risk-adjusted performance, and Beta by itself is a risk metric, not a return measure.

Risk-adjusted return is about evaluating how much return you earn for each unit of risk you take. The most common way to measure this is the Sharpe ratio, which compares the portfolio’s excess return over a risk-free rate to its total volatility. In simple terms, you subtract the risk-free return from what you earned, then divide by how much the investment’s returns swung. This ratio tells you how efficiently a portfolio converts risk into higher returns—the higher the better.

Other measures exist but focus on different kinds of risk. The Treynor ratio uses only systematic risk (beta) rather than total volatility, and the Sortino ratio uses downside risk instead of all volatility. Inflation adjustment would give you real returns, not risk-adjusted performance, and Beta by itself is a risk metric, not a return measure.

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