Explaining risk adjusted returns
When evaluating investments, returns alone don’t tell the whole story. It’s also important to understand how much risk you are taking to generate those returns.
JioBlackRock advantage
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Published on 7 May 2026
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3 min read
Measuring how much risk is taken to generate a specific return is a more thorough way to evaluate investments than comparing straight gains or losses because it factors in how much risk each investment carries.
Consider this example:
| Portfolio | Annual return | Risk (volatility) |
|---|---|---|
| A | 12% | 15% |
| B | 10% | 8% |
At first glance, Portfolio A seems more attractive because it offers a high return. Yet it also comes with nearly double the risk of Portfolio B. To know if you’re being fairly compensated for the risk you’re taking, you need to compare the risk-adjusted return of both portfolios.
How is risk-adjusted return calculated?
Formula:
Comparing investments: a practical example
| Investment | Annual return | Risk-free rate | Volatility | Sharpe ratio |
|---|---|---|---|---|
| A | 11% | 1% | 10% | 1.0 |
| B | 11% | 1% | 20% | 0.5 |
This illustration uses a treasury (short-term government bond) risk-free rate because treasuries are some of the most risk-free assets available to investors. The table above shows two hypothetical investments. The Sharpe ratio shows that investment B suffers twice as much volatility to earn the same returns as investment A. So, while both investments earn the same return of 11%, investment A is a better performer on a risk-adjusted basis.
Why risk-adjusted return matters
A diversified portfolio aligned with your risk tolerance and objectives may feel slower but increases your chances of reaching your financial destination safely.
Bottom line: Look beyond flashy numbers
Questions you might have
This article is for educational purpose only.
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