Sortino Ratio Calculator
The Sortino Ratio is a modification of the Sharpe Ratio that only considers downside risk. It is used to measure the risk-adjusted return of an investment, taking into account the negative deviation from a required return rather than the overall volatility. This makes the Sortino Ratio a more accurate measure of performance for investments that are sensitive to downside risk.
Formula
The formula for calculating the Sortino Ratio is:
Sortino Ratio (SR) = (Average Return (AR) − Required Return (RR)) / Target Downside Deviation (TD)
Where:
- AR = Average Return of the investment
- RR = Required Return or the minimum acceptable return
- TD = Target Downside Deviation, which measures the negative deviation from the required return
How to Use
- Enter the average return of the investment in the first input field.
- Enter the required return (the minimum acceptable return) in the second field.
- Enter the target downside deviation in the third field.
- Click the “Calculate” button, and the Sortino Ratio will be displayed in the result field.
Example
Suppose an investment has an average return of 12%, a required return of 5%, and a target downside deviation of 8%. Using the formula:
Sortino Ratio = (12% − 5%) / 8%
Sortino Ratio = 7% / 8%
Sortino Ratio = 0.875
Thus, the Sortino Ratio for this investment is 0.875, indicating a moderately risk-adjusted return.
FAQs
- What is the Sortino Ratio?
The Sortino Ratio is a financial metric that measures the risk-adjusted return of an investment by focusing only on downside risk rather than overall volatility. - How is the Sortino Ratio different from the Sharpe Ratio?
While the Sharpe Ratio considers both upside and downside volatility, the Sortino Ratio focuses only on downside volatility, making it more useful when downside risk is the main concern. - Why is the Sortino Ratio important?
It helps investors evaluate performance by isolating the downside risk, which is particularly important for those who are more risk-averse and concerned with avoiding losses. - What is the ideal value for the Sortino Ratio?
A higher Sortino Ratio is preferable, as it indicates that the investment is providing higher returns per unit of downside risk. - Can the Sortino Ratio be negative?
Yes, a negative Sortino Ratio indicates that the investment is not generating sufficient returns to cover the required return, given the downside risk. - What is downside deviation?
Downside deviation measures the deviation of the investment’s returns below a required or target return, focusing only on the negative performance. - Is a higher or lower Sortino Ratio better?
A higher Sortino Ratio is better, as it signifies that the investment is generating higher returns relative to the downside risk. - What is required return in the Sortino Ratio?
The required return is the minimum acceptable return an investor expects from an investment. It’s used as a benchmark for calculating downside risk. - When should I use the Sortino Ratio over the Sharpe Ratio?
The Sortino Ratio is preferred when you are primarily concerned with downside risk rather than overall volatility. - Can I use the Sortino Ratio for any investment?
Yes, the Sortino Ratio can be used for any investment, especially those that experience significant downside risk. - How do I calculate target downside deviation?
Target downside deviation is calculated by measuring the negative deviation of the investment’s returns below the required return over a given period. - Is the Sortino Ratio better for long-term or short-term investments?
The Sortino Ratio is useful for both long-term and short-term investments but is particularly valuable for investments where downside risk needs to be managed closely. - Can the Sortino Ratio help in portfolio optimization?
Yes, it can help in constructing portfolios by selecting investments that offer the best risk-adjusted returns based on downside risk. - How does volatility affect the Sortino Ratio?
The Sortino Ratio focuses on downside volatility rather than overall volatility, making it more relevant for risk-averse investors. - What does a Sortino Ratio of 1 mean?
A Sortino Ratio of 1 means that the investment’s returns are equal to its downside risk, which is considered a neutral result. - What are the limitations of the Sortino Ratio?
The Sortino Ratio does not account for upside volatility, so it may undervalue investments that experience high positive performance. - What is a good Sortino Ratio for a stock portfolio?
A Sortino Ratio above 1 is generally considered good, while a ratio above 2 is considered excellent. - Can I use the Sortino Ratio to compare different investments?
Yes, the Sortino Ratio is a useful tool for comparing different investments based on their risk-adjusted returns. - How is the Sortino Ratio used in performance evaluation?
It helps investors assess whether an investment is providing adequate returns for the amount of downside risk it carries. - What types of investors benefit most from the Sortino Ratio?
Risk-averse investors and those concerned with minimizing losses can benefit most from using the Sortino Ratio.
Conclusion
The Sortino Ratio is a powerful tool for evaluating risk-adjusted returns, particularly when downside risk is the primary concern. By focusing only on negative volatility, the Sortino Ratio provides a clearer picture of how well an investment performs relative to the risk of loss. Use this calculator to quickly determine the Sortino Ratio for any investment and make better-informed decisions when assessing potential risks and returns.