The Sharpe ratio, developed by Nobel laureate William F. Sharpe, is one of the most widely used metrics for evaluating risk-adjusted investment performance. It measures how much excess return you receive for each unit of volatility (risk) in your portfolio. The formula is: Sharpe Ratio = (Rp - Rf) / σp, where Rp is the portfolio return, Rf is the risk-free rate, and σp is the standard deviation of portfolio returns.

A Sharpe ratio below 1.0 is generally considered sub-optimal, meaning the risk taken is not being sufficiently compensated with returns. A ratio between 1.0 and 2.0 is considered adequate to good, while ratios above 2.0 suggest very good risk-adjusted performance. A ratio above 3.0 is exceptional and rarely sustained over long periods. Negative Sharpe ratios mean the portfolio is underperforming a risk-free investment.

For example, a portfolio returning 12% with a risk-free rate of 4% and a standard deviation of 15% has a Sharpe ratio of 0.53. This indicates that for each unit of risk, the investor earns about half a unit of excess return. The Sharpe ratio is most useful for comparing portfolios with similar investment objectives, as it provides a standardized measure of return per unit of risk.