This calculator gives estimates for education and planning. It is not investment, tax or legal advice; for decisions about your own situation, talk to a qualified financial professional.
Measuring return per unit of bad risk
Two funds with the same return are not equally attractive if one got there with far deeper losses. Risk-adjusted ratios compare return with risk. The best known, the Sharpe ratio, uses total volatility, which treats a sudden 10% gain as just as risky as a 10% loss. The Sortino ratio, developed by Frank Sortino in the 1980s, only counts downside volatility, the swings below a target return that investors actually fear.
The formula
- Sortino ratio = (portfolio return − target return) ÷ downside deviation
- Sharpe ratio = (portfolio return − risk-free rate) ÷ standard deviation
The target, or minimum acceptable return (MAR), can be zero, the risk-free rate, inflation or a goal such as the return needed to fund a pension.
Downside deviation
For a series of returns:
- For each period, take the shortfall below the target, or zero if the return is at or above it.
- Square each shortfall.
- Average over all periods, including the zeros.
- Take the square root.
- Annualize: multiply monthly figures by √12, about 3.46.
Example
A portfolio with an annual return of 9%, a target of 2%, a downside deviation of 8% and a total volatility of 15%, with a risk-free rate of 3%:
- Sortino ratio: (9 − 2) ÷ 8 = 0.875
- Sharpe ratio: (9 − 3) ÷ 15 = 0.40
The Sortino ratio is higher here because much of the fund’s volatility comes from gains. A fund whose volatility is mostly losses would show similar Sharpe and Sortino ratios.
Interpreting it
| Sortino ratio | Rough reading |
|---|---|
| Below 0 | Return below the target |
| 0 – 1 | Positive but modest |
| 1 – 2 | Good |
| Above 2 | Excellent |
These are rules of thumb. The ratio depends heavily on the period, the target and the frequency of returns, so compare funds only on the same basis, and over a full market cycle if possible.
Limits
- Few periods below the target give an unstable downside deviation, so the ratio can look excellent by luck.
- Like any historical measure, it says nothing certain about future returns.
- It ignores how losses are clustered; the maximum drawdown or the Calmar ratio complete the picture for investors worried about deep, lasting losses.