What is the Sharpe ratio and how is it interpreted?

The Sharpe ratio is the excess return over the risk-free rate or a benchmark divided by the standard deviation of returns, showing how much reward was earned per unit of risk.

When two investments are compared on the same basis, the one with the higher Sharpe ratio can be interpreted as having earned a higher return for the same risk. However, if the return data used in the calculation are inaccurate or smoothed, the ratio may look better than it really is.