📊Sortino Ratio: Unlock Investment Analysis
Dive into the world of investment analysis with the Sortino Ratio, a powerful tool for assessing risk-adjusted returns.
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Sortino Ratio: Unlock Investment Analysis
Which is better Sortino ratio or Sharpe ratio?
Calculating the Ratios
The Pros and Cons
So, Which is Better?
Case Study [Free]:
What is the best US Index ETF accordingly with Sortino Ratio?
Bottom Line
Sortino Ratio
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A subscriber sent us this question:
Good investment is a combination of making the right decision at the right time.
And to do that, we need the right tools.
Today, we're putting two heavyweights in the ring: the Sortino ratio and the Sharpe ratio. The burning question on everyone's mind is, "Which is better, Sortino ratio or Sharpe ratio?"
The answer is the Sortino Ratio.
Let's roll up our sleeves and dive into the nitty-gritty of these financial metrics and see what American index is the best accordingly to this analysis.
Have a question too? You can leave a comment:
Which is better Sortino ratio or Sharpe ratio?
The Sharpe Ratio: A Quick Overview
The Sharpe ratio, named after Nobel Laureate William F. Sharpe, is a measure of risk-adjusted return.
It's like a financial yardstick, comparing the performance of an equity investment to a risk-free investment, considering the additional risk level.
The higher the Sharpe ratio, the better the investment's returns relative to the risk it took to achieve those returns.
The Sortino Ratio: The Basics
Enter the Sortino ratio, a variation of the Sharpe ratio that only factors in downside risk.
Developed by Frank Sortino, it's a tool that focuses on the potential for a negative deviation from the mean, or in simpler terms, the risk of a bad outcome.
A bad outcome all we don’t want in our Portfolio. That’s why the Sortino Ratio is better.
The higher the Sortino ratio, the better the investment's returns relative to its downside risk.
Calculating the Ratios
Crunching the Numbers: Sharpe Ratio
The Sharpe ratio is calculated by subtracting the risk-free rate from the expected return of the investment and dividing the result by the standard deviation of the investment's returns.
Sharpe Ratio = (Portfolio Return - Risk-Free Rate) / Portfolio Standard Deviation
It's a straightforward formula, but it does have its limitations, which we'll get to in a bit.
Doing the Math: Sortino Ratio
The Sortino ratio, on the other hand, uses a similar formula but replaces the standard deviation of the investment's returns with the standard deviation of the negative returns.
Sortino Ratio = (Portfolio Return - Risk-Free Rate) / Portfolio Downside Deviation
This tweak allows the Sortino ratio to focus solely on the downside risk, which many investors find more relevant.
The Pros and Cons
The Sharpe Ratio: Strengths and Weaknesses
The Sharpe ratio's simplicity and widespread use are its main advantages.
It's a quick and easy way to get a sense of an investment's risk-adjusted return. However, it doesn't take into account the investor's goals, risk tolerance, or time horizon.
Plus, it treats all volatility—upside and downside—as the same, which isn't always ideal.
The Sortino Ratio: Advantages and Disadvantages
The Sortino ratio shines by considering the investor's goals and risk tolerance.
It's a more nuanced tool, especially useful when dealing with investments that have a high potential for negative returns.
However, it's more complex and less popular than the Sharpe ratio, and like its counterpart, it doesn't consider liquidity and taxability.
So, Which is Better?
The Verdict
The Sortino Ratio is better accordingly to our system, because all we want is a high positive volatility in our positions.
Case Study: What is the best US Index ETF?
Accordingly with the Sortino Ratio
For this analysis we will use the MacroAxis Platform.
SPY 0.00%↑: SPDR SP 500 has current Sortino Ratio of 0.1392
Sortino Ratio = (ER[a] - ER[b] )/DD = 0.1392
DIA 0.00%↑: SPDR Dow Jones has current Sortino Ratio of 0.0131.
Sortino Ratio = (ER[a] - ER[b] )/DD = 0.0131
QQQ 0.00%↑: Invesco QQQ Trust has current Sortino Ratio of 0.2376
Sortino Ratio = (ER[a] - ER[b] )/DD = 0.2376
IWM 0.00%↑: IShares Russell 2000 has current Sortino Ratio of 0.0327
The higher the Sortino ratio, the better the investment's returns relative to its downside risk. So, the Best US Index ETF accordingly with the Sortino Ratio by the time we are writing this article is the Invesco QQQ Trust
This analysis are not investment recommendations and investors must do their own research (please read the Disclaimer section).
We invest our own money and share our Portfolio with Premium Subscribers.
Premium Subscribers have full access to our Alfa Hedge Portfolio II in a Real-Life Brokerage Account in Real Time.
Bottom Line
Both the Sortino Ratio and the Sharpe Ratio are valuable tools for measuring an investment’s risk.
However, the Sortino Ratio's focus on downside risk makes it a more precise tool for assessing risk-adjusted returns, particularly for high volatility assets.
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