The smart Sortino ratio calculator is an efficient tool that indicates the return of an investment considering its drawdown risk.
This article will cover the definition of the Sortino ratio, see a formula for calculating it, and discuss what a good Sortino ratio is. As a bonus, we'll go through a real-life example of a Sortino ratio calculation!
What is the Sortino ratio?
The Sortino ratio is a statistical tool that investment managers use in portfolio risk analysis. It considers the historic asset returns, the risk-free rate, and the negative asset volatility. It indicates how much profit you could earn in exchange for the risk you are taking.
Wait, negative what? 😨
We understand how you feel. Do not worry. We have you covered. The Sortino ratio is an improvement of the sharpe ratio calculator because it only considers negative returns of the asset. In contrast, the latter considers both (positive and negative returns). Negative volatility is another name investors use to refer to the swing in price that causes lower values.
What is a negative stock return?
It is when the stock reports a decrease in its price value from one date to the other. On the other hand, a positive stock return is when the stock price increases.
But what about the risk-free rate?
The risk-free rate refers to a profit you can make from an investment with literally no risk of losing money. Bonds from governments are usually this kind of investment.
In a nutshell, the Sortino rate subtracts the risk-free rate from the historical return and divides it by the negative return volatility. The result indicates how much extra return you are gaining, given the risk you are taking.
How to calculate the Sortino ratio?
As we mentioned above, the Sortino ratio formula is:
- — Average return on the asset;
- — Risk-free rate; and
- — Standard deviation of the downside or any negative return the company experienced.
The risk-free rate can be the interest rate that your government pays for its bonds. In our example, we will use the US 3-month treasury bill bond.
The standard deviation of the downside only considers the negative returns, replacing the positive values in the historical returns with 0.
Can you show a Sortino ratio calculation example?
Sure. Let's consider the following data:
Over the last 20 years, the average return has been: .
The current .:
The next step is to find out the negative returns' standard deviation (STD). We only need to replace the positive returns with 0 and calculate the STD of all the remaining monthly returns. Thus, we obtain the following:
Finally, by using the Sortino ratio formula, we get:
We can conduct the same Sortino ratio calculation example for Microsoft (
advanced mode button. The MSFT data is:
In conclusion, we note that although MSFT's negative risk is lower, the average monthly return of APPL is so much larger that it makes its Sortino ratio better. Consequently, we can say that an investment in Apple showed better returns for the risk taken compared to Microsoft over the last 20 years.
⚠️ Note: The risk-free rate we consider for our Sortino ratio calculator example is the three-month treasury bill rate which is constantly changing. Please use the updated risk-free rate valid when you perform your calculations.
How do investors use Sortino ratio?
The question you might have had from the very beginning is: What is a good Sortino ratio? There is a simple answer to such a question: the higher, the better.
When you compare the Sortino ratio of different stocks, you look for the one with the larger value. It means it is the one that has provided the most significant return for the less drawdown risk.
You will probably find the most significant Sortino ratio in the stocks that report high revenue growth and high free cash flow margin. Both financial indicators show business strength and profitability, which in the market means excellent returns.
Finally, always consider analyzing your assets as a whole. We recommend you check the portfolio beta calculator for such a job.
Which is better out of Sortino ratio vs Sharpe ratio?
Investors consider the Sortino ratio to be superior to the Sharpe ratio because it only considers the negative risk (drawdowns). In that sense, the former ratio shows the historic return compared to the probability of getting losses, which is the only risk that matters.
How do I calculate the Sortino ratio?
Perform these steps to calculator the Sortino ratio:
Obtain the historical stock price considering at least the last five years.
Calculate the returns. You decide whether to use daily, monthly, or yearly, depending on the size of your dataset. Remember, the last price is divided by the previous price minus 1. Continue multiplying the result by 100%.
Get the average of the returns (
Ra). Also, obtain the risk-free rate (
Compute the standard deviation only of the negative returns (
Raand divide by
What is a good Sortino ratio?
When comparing stocks, the one with a larger Sortino ratio is better. In any case, you want to keep in mind the list:
- Sortino ratio > 1: a good risk/return (R/R) profile.
- Sortino ratio > 2: a great R/R profile.
- Sortino ratio > 3: an excellent R/R profile.
What is a bad Sortino ratio?
A negative Sortino ratio is terrible because it indicates that the investor could have gotten a better return with no risk by investing in a risk-free option like government bonds (treasury bills). In other words, the investor took more risks and still got poorer results.