Portfolio ManagementAdvanced
Understanding Risk-Adjusted Returns
Why comparing raw returns alone can be misleading, and how risk-adjusted measures help.
5 min readPublished 2026-09-28
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Key takeaways
What to remember
- Raw return comparisons ignore how much risk was taken to achieve them.
- Risk-adjusted measures like the Sharpe ratio account for volatility alongside return.
- A lower raw return can still represent a more favorable risk-adjusted outcome.
- Risk-adjusted measures add a useful additional comparison dimension, not a single final verdict.
The problem with comparing raw returns alone
Two investments with the same raw percentage return can have taken on very different amounts of risk to achieve it — comparing raw returns alone ignores this real difference.
What risk-adjusted measures do
A risk-adjusted return measure, such as the Sharpe ratio, expresses return relative to the volatility taken on to achieve it, letting investments with different risk profiles be compared on a more like-for-like basis.
A practical example
- An asset returning 20% with high volatility may have a less favorable risk-adjusted return than one returning 12% with much lower volatility.
- Risk-adjusted measures don't say one investment is objectively "better" — they add a genuinely useful additional dimension to the comparison.
Why it matters
Raw return and risk-adjusted return can tell different stories
The higher-raw-return investment isn't automatically the more attractive one once the risk taken to achieve that return is accounted for.
What to remember
- Raw return comparisons ignore how much risk was taken to achieve them.
- Risk-adjusted measures like the Sharpe ratio account for volatility alongside return.
- A lower raw return can still represent a more favorable risk-adjusted outcome.
- Risk-adjusted measures add a useful additional comparison dimension, not a single final verdict.