The Sharpe ratio measures how much return a portfolio earns for each unit of risk it takes, with risk defined as the volatility (standard deviation) of its returns. Two portfolios can both make 12% a year — the one that got there with smaller swings has the higher Sharpe ratio.
A high Sharpe ratio does not mean a portfolio is risky — it means the risk it does take is being well paid.
Lemma Analysis computes it on monthly flow-adjusted returns with the risk-free rate taken as 0 (simplified Sharpe), so the figure runs slightly higher than services that subtract the T-bill rate.
A portfolio averaging +1.0% per month with a monthly standard deviation of 2.5% has an annualized Sharpe of about 1.39:
The same average return with 5% monthly volatility would halve the Sharpe to ~0.69 — same destination, twice the turbulence.
Higher is better. For context, the long-term S&P 500 lives around 0.5–0.7 on this simplified definition. Reference bands on monthly data:
| Sharpe | Reading |
|---|---|
| < 0 | the portfolio loses money on average |
| 0–0.5 | weak — risk is poorly paid |
| 0.5–1.0 | acceptable; broad-market territory |
| 1.0–2.0 | good |
| 2.0–3.0 | excellent, rare over 5+ years |
| > 3.0 | suspicious: short history, a calm bull stretch, or a data issue |
Read it together with the Sortino ratio: if Sortino is far above Sharpe, most of your volatility is upside — less worrying than it looks.
Sharpe matters whenever you compare two strategies with different risk levels — raw returns alone reward whoever took the most risk in a bull market. It is the standard yardstick for risk-adjusted performance.
It punishes upside and downside volatility equally, so explosive-but-profitable portfolios look worse than they feel. With risk-free assumed 0, comparisons against services that subtract T-bill rates will differ — especially when rates are high. Monthly granularity smooths volatility, nudging the ratio up versus daily data. Short histories make it noisy; the bands above are meaningful from roughly 2–3 years of history.