# Sortino Ratio: The Ideal Risk Measure for Your Investment Strategy

### 🔀Knowledge Hub Series: What is the Sortino Ratio? / Sortino Ratio Calculation / Sortino Ratio vs. Sharpe Ratio / What is a Good Sortino Ratio for a Fund?

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# Sortino Ratio: The Ideal Risk Measure for Your Investment Strategy

One of the most effective tools for measuring risk-adjusted returns is the Sortino Ratio. But what exactly is it? How is it calculated? And how does it compare to other ratios like the Sharpe Ratio? This article delves into these questions and provides a step-by-step guide on calculating the Sortino Ratio in Excel.

## What is the Sortino Ratio?

The Sortino Ratio is a financial metric that measures the risk-adjusted return of an investment. Unlike the Sharpe Ratio, which considers total volatility, the Sortino Ratio focuses solely on downside risk, providing a clearer picture of an investment's performance relative to its risk.

### Meaning and Definition

The Sortino Ratio is defined as the difference between the investment's return and the risk-free rate, divided by the standard deviation of negative asset returns (downside deviation). This ratio is particularly useful for investors who are more concerned with downside risk rather than overall volatility.

## Sortino Ratio Calculation

### Sortino Ratio Formula

### How to Calculate Sortino Ratio in Excel

Calculating the Sortino Ratio in Excel involves a few straightforward steps:

**Gather Data**: Collect the historical returns of the investment and the risk-free rate.**Calculate Excess Returns**: Subtract the risk-free rate from each historical return.**Identify Negative Returns**: Filter out periods where the excess returns are negative.**Calculate Downside Deviation**: Compute the standard deviation of the negative excess returns.**Apply the Formula**: Use the Sortino Ratio formula to find the ratio.

#### Step-by-Step Example in Excel

**Input Data**:Column A: Historical Returns

Column B: Risk-Free Rate (constant value)

**Calculate Excess Returns**:

`=A2 - $B$1`

**Identify Negative Returns**:

`=IF(C2 < 0, C2, 0)`

**Calculate Downside Deviation**:

`=STDEV.P(D2:Dn) // where D2:Dn contains negative returns`

**Apply Sortino Ratio Formula**:

`=(AVERAGE(A2:An) - B1) / E2 // where E2 contains downside deviation`

## Sortino Ratio vs. Sharpe Ratio

While both the Sortino and Sharpe Ratios are used to measure risk-adjusted returns, they have distinct differences:

**Sortino Ratio**: Focuses only on downside risk, making it more appropriate for investors who are particularly concerned with negative returns.**Sharpe Ratio**: Considers total volatility, including both upside and downside risks.

## What is a Good Sortino Ratio for a Fund?

A good Sortino Ratio is highly dependent on the investment strategy of the fund. Generally, a Sortino Ratio above 1 is considered a good reference point:

**Below 1**: Indicates subpar performance relative to the risk taken.**Above 1**: Suggests acceptable to excellent performance, depending on the fund's specific strategy and goals.

Investors often aim for a Sortino Ratio above 1 to ensure a favorable risk-adjusted return, reflecting the fund's ability to manage downside risk effectively while achieving desirable returns.

## Conclusion

The Sortino Ratio is an invaluable tool for assessing the risk-adjusted performance of an investment, particularly for those focused on downside risk.

By understanding its calculation, differences from the Sharpe Ratio, and the benchmarks for a good ratio, investors can make more informed decisions.

Whether you’re an individual investor or managing a fund, integrating the Sortino Ratio into your analysis can provide deeper insights into your investment’s true performance.