Risk-Adjusted Return

A risk-adjusted return is a calculation of the profit or potential profit from an investment that takes into account the degree of risk that must be accepted in order to achieve it. An investment’s risk-adjusted return takes the total return and adjusts for the degree of risk as measured by volatility. In essence, a high-risk investment strategy needs to generate a minimal level of returns above the risk-free rate of return to justify pursuing it. In other words, given two investment options with the same or similar rates of return, an investor should always choose the lowest risk option, on the basis that the risk of loss of the investment with the higher risk exposes the investor to a higher risk of loss. A widely used metric to measure risk-adjusted returns is applying the Sharpe ratio, which measures average returns over the risk-free rate adjusted for the standard deviation of those returns.