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Audit the downside. Calculate the Sortino Ratio to measure risk-adjusted return while focusing only on harmful negative volatility.
Step-by-step breakdown of the underlying equations.
While the Sharpe ratio penalizes "good" upside volatility, the **Sortino Ratio** only penalizes "bad" downside deviation. A ratio of 1.00means you are effectively managing the risk of losses while capturing growth. A Sortino > 2.0 is generally considered very strong.
The Sortino Ratio Calculator measures risk-adjusted returns by focusing specifically on downside risk—the volatility of negative returns below your minimum acceptable return (MAR). Unlike the Sharpe Ratio, it doesn't penalize positive volatility (upside surprises).
This makes it a more intuitive measure for most investors who are primarily concerned with protecting against losses rather than smoothing out gains.
Scenario: Portfolio A returned 12% annually. Your minimum acceptable return is 5% (the risk-free rate). The downside deviation (volatility of returns below 5%) is 7%.
Note: Compare similar investments using the same target return. A higher Sortino means better risk-adjusted returns considering only harmful volatility.
The Sharpe Ratio penalizes all volatility equally—both upside and downside. The Sortino Ratio only penalizes downside deviation (volatility below your target return). This makes Sortino more relevant for most investors who don't mind upside volatility (big gains) but want to avoid downside risk (losses).
A Sortino Ratio above 2.0 is generally considered excellent—you're getting twice as much excess return per unit of downside risk. Between 1.0-2.0 is good. Below 1.0 suggests the investment isn't adequately compensating for its downside risk. Negative means the investment returns less than your target.
Downside deviation measures the standard deviation of returns that fall below your target (MAR). Steps: (1) Identify all returns below your target, (2) Calculate how far each is below target, (3) Square these differences, (4) Average them, (5) Take the square root. Only negative deviations from target matter—positive returns are ignored in this calculation.
Common choices include: the risk-free rate (Treasury bills, ~4-5% currently), zero (you just want to avoid losses), your required return (e.g., 7% to meet retirement goals), or inflation rate (to maintain purchasing power). The choice depends on your investment objectives.
This happens when an investment has lots of upside volatility but little downside volatility—explosive gains but limited losses. In this case, Sharpe penalizes the 'good' volatility while Sortino doesn't. Conversely, high Sortino with low Sharpe suggests steady upside but potentially significant drawdowns.