Most people invest not just to grow their money — but to do so without suffering big setbacks along the way.
While high returns are tempting, the real challenge is earning them consistently, without exposing yourself to damaging losses.
The Sortino ratio helps you judge how well an investment delivers on that goal. It shows how much return you're earning above a target — for each unit of downside risk you're taking.
Unlike other metrics, it ignores harmless volatility and focuses only on the parts that hurt: the drawdowns.
A Sortino ratio of 1.0 means you're earning one unit of return for every unit of downside risk.
Higher values suggest your portfolio is delivering more gain than pain.
Lower values may indicate you're not being fairly rewarded for the risks you're taking — especially if your returns frequently dip below your goal.
By filtering out upside noise and focusing only on negative deviations, the Sortino ratio gives you a more realistic picture of how your investments behave when it matters most — when things go wrong.
Measures return in relation to downside volatility — not total volatility.
•
Aligns with real goals:
Helps evaluate performance against a target return — useful for drawdown or income strategies.
•
Behaviourally grounded:
Matches how most investors think about risk — as the chance of falling short, not just fluctuating.
Small changes in the target return can significantly shift the result.
If downside deviations are rare, the ratio may appear artificially high.
Sharp positive swings are excluded — which may mask real volatility concerns in some strategies.
1. What is the Sortino ratio?
The Sortino ratio measures how much
excess return
The return above a target or “minimum acceptable” return — often set as 0% or the risk-free rate.
an investment delivers for each unit of
downside risk
The degree to which returns fall below a chosen threshold — ignoring any volatility from strong positive returns.
.
It improves on the
Sharpe ratio by focusing only on harmful volatility, rather than treating all fluctuations as equally risky.
Unlike the
Sharpe ratio — which penalises both good and bad volatility — the Sortino ratio isolates the parts of performance that matter most to cautious investors: the negative surprises.
In doing so, it offers a more realistic picture of risk-adjusted return, especially for those aiming to avoid losses rather than simply chase gains.
The ratio is named after Frank A. Sortino, a US academic who introduced the concept in the 1980s as an enhancement to
modern portfolio theory.
His goal was to better reflect the concerns of real-world investors, who are more sensitive to downside risk than symmetrical ups and downs.
The Sortino ratio has since become a standard tool in investment analysis — especially for income-seeking portfolios, retirement drawdown strategies, or any approach where avoiding losses is more important than maximising every potential gain.
Here’s a quick primer on the terms behind the Sortino ratio.
| Term |
What it means |
| Excess return |
The return above a target level, such as 0%, inflation, or a risk-free benchmark. |
| Target return |
The minimum acceptable return (MAR) used as the benchmark — typically set by investor goals. |
| Downside deviation |
Measures how far and how often returns fall below the target — unlike standard deviation, it ignores gains. |
| Sortino ratio |
A metric that shows how well an investment rewards you for each unit of downside risk taken. |
2. The Sortino ratio formula
The Sortino ratio compares an investment’s excess return
The amount earned above a target return — typically 0%, inflation, or a minimum acceptable return (MAR).
to its downside deviation
A measure of how much returns fall short of the target — ignoring any positive deviations.
.
It asks a critical question: how much return are you earning for every unit of downside risk?
Formula: The basic version is:
Where:
Rp = Return of the portfolio or investment
Rt = Target return (or minimum acceptable return)
σd = Downside deviation of the portfolio’s returns
Unlike standard deviation — which counts both gains and losses as volatility — downside deviation only considers returns that fall below the target. This makes the denominator smaller, and the result more forgiving of strong positive fluctuations.
The Sortino ratio can be calculated using monthly, quarterly, or annual returns — as long as you’re consistent.
If you use monthly data and want an annualised result, multiply the ratio by √12. For weekly data, use √52; for daily, √252.
Be sure that your target return
The benchmark used to define “acceptable” performance — often set as 0%, inflation, or a minimum goal.
is expressed in the same time frame as your performance data.
For example, if you're using monthly returns, make sure your target return is also monthly — not annual.
Mismatched units can distort the result and lead to misleading conclusions.
3. Interpreting the results
The Sortino ratio helps answer a vital question: are you being fairly rewarded for the downside risk
The risk of returns falling below a target level — not just any volatility, but the kind that threatens your goals.
you’re taking?
It ignores positive fluctuations — which means it focuses only on return shortfalls, not overall variability.
In practical terms, a Sortino ratio of 1 or higher is usually seen as good.
It means you’re earning at least one unit of excess return for each unit of downside risk taken. The higher the ratio, the more efficiently your investment avoids negative surprises while still generating strong returns.
Here’s how different Sortino ratios are typically interpreted:
| Sortino ratio |
Interpretation |
Rating |
| Above 2.0 |
Exceptional performance — high returns with minimal downside risk |
+++ |
| 1.0 to 2.0 |
Solid risk-adjusted return — fairly compensated for downside exposure |
++ |
| 0.0 to 1.0 |
Below average — returns may not justify downside volatility |
+ |
| Below 0 |
Negative excess return — underperformed the target or MAR |
– |
Sortino ratios can vary significantly depending on how the calculation is framed:
-
Target return: – A higher benchmark (e.g. 5%) lowers the ratio, while 0% raises it. Choose a relevant MAR for your goals.
-
Data frequency: – Monthly vs annual data can produce different outcomes. Stay consistent.
-
Sample size: – Short periods or calm markets may underestimate downside deviation — inflating the ratio.
4. Sortino in action: worked example
Let’s compare three portfolios that each deliver an average return of 8% over five years.
On the surface, they look equally attractive — but the downside deviation
A measure of how far returns fall below a target — not how volatile they are overall.
tells a different story.
| Year |
Portfolio A |
Portfolio B |
Portfolio C |
| 1 | 8.0% | 15.0% | -6.0% |
| 2 | 8.0% | 3.0% | 16.0% |
| 3 | 8.0% | 6.0% | 5.0% |
| 4 | 8.0% | 7.0% | 13.0% |
| 5 | 8.0% | 9.0% | 12.0% |
| Average return | 8.0% | 8.0% | 8.0% |
| Target return (Rt) | 3% | 3% | 3% |
| Downside deviation | 0.0% | 3.24% | 6.90% |
| Sortino ratio | ∞ or undefined | 1.54 | 0.72 |
Portfolio A is perfectly consistent: no downside volatility at all. Because returns never fall below the 3% target, downside deviation is zero — which results in an infinite or undefined Sortino ratio.
Portfolio B fluctuates, but never drops sharply below the target. Its downside deviation is modest, and its Sortino ratio is comfortably above 1 — indicating efficient risk-adjusted return.
Portfolio C swings the most. It includes a sharp negative return in Year 1, creating the largest downside deviation. Despite the same average return as A and B, its Sortino ratio is under 1 — suggesting the path taken involved more downside risk than the reward may justify.
- Portfolio A: Hypothetical stability — no returns below target, so the Sortino ratio is infinite.
- Portfolio B: Slight downside deviation but strong consistency — a healthy Sortino ratio.
- Portfolio C: Sharp negative year drags the ratio down — riskier path, despite decent outcome.
All three portfolios achieved the same average return — but only one (Portfolio B) did so with a strong balance of return versus downside risk.
That’s what the Sortino ratio helps reveal: not just what you earned, but whether you reached your goals without too many painful setbacks.
5. Why downside risk matters
Not all volatility is bad. If your investment jumps 20% in a single year, that's technically volatile — but it's not a problem.
Traditional risk metrics like the
Sharpe ratio treat upside and downside volatility the same.
The Sortino ratio focuses only on downside deviation
The extent to which returns fall below a target or acceptable level — ignoring positive outliers.
,
which many investors see as a truer measure of risk. Why penalise strong gains if they don’t threaten your goals?
Here's why targeting downside risk — not just total volatility — can give a clearer picture of real-world investment quality:
-
It reflects real anxiety: – Most investors don’t fear upside surprises — they worry about losing money.
-
It links to actual goals: – In drawdown strategies or income planning, falling short of a target matters more than bouncing above it.
-
It rewards smoother downside: – A strategy with few, shallow losses gets credit — even if total volatility is high.
-
It helps you stay invested: – Lower downside risk often means fewer panic-driven exits or bad decisions under stress.
By filtering out “happy volatility” and focusing only on losses, the Sortino ratio better aligns with how many investors experience risk — emotionally, financially, and behaviourally.
6. When is the Sortino ratio useful?
The Sortino ratio is most useful when you want to focus on protecting your downside — not just balancing all volatility.
It’s especially helpful for investors with specific minimum return goals, or those whose priority is capital preservation over maximum growth.
The Sortino ratio is most powerful when used with clear goals and consistent data — and alongside other tools that reveal different aspects of risk.
Sortino works best in situations where losses matter more than fluctuations:
-
Retirement and drawdown strategies:
– Helps assess how well a portfolio avoids dipping below a target return or income level.
-
Defensive or capital preservation funds:
– Especially relevant for funds promising low drawdowns or downside protection.
-
Goal-based investing:
– If your aim is to avoid falling below inflation or a fixed target, Sortino reflects that more accurately than Sharpe.
-
Funds with asymmetric risk:
– Strategies with more upside than downside movement benefit from being judged on downside alone.
Like all metrics, the Sortino ratio has its blind spots. It won’t always suit every situation — and can sometimes be misleading if misunderstood:
-
Too few downside events:
– If the investment rarely falls below the target, the downside deviation might be tiny — inflating the ratio.
-
No penalty for “choppy” upside:
– Wild positive swings aren’t penalised — which can be misleading in volatility-sensitive strategies.
-
Only as good as your target:
– Choose a sensible minimum acceptable return
Your chosen benchmark — often 0%, inflation, or the risk-free rate — used to determine what counts as “downside.”
. Too low or too high can distort the result.
The Sortino ratio assumes that returns below the target follow a roughly normal distribution.
In practice, many assets — such as crypto, leveraged ETFs, or options-based strategies — exhibit
fat tails
Distributions where extreme losses (or gains) are more likely than a normal curve would predict.
or skewed patterns. In these cases, downside deviation may significantly understate true risk.
Use additional risk metrics or scenario analysis when evaluating portfolios exposed to tail events or irregular return behaviour.
7. Strengths and limitations
The Sortino ratio is a powerful refinement of the
Sharpe ratio — focusing only on downside risk instead of all volatility.
That makes it especially relevant for real-world investors who care more about protecting their capital than smoothing every fluctuation.
But like all single-number metrics, it has its blind spots.
For a fuller picture, many professionals use the Sortino ratio alongside other tools like the
Sharpe ratio,
Treynor ratio, or
Calmar ratio (which focuses on drawdowns).
Strengths
- ✓ Focuses on the type of risk investors care most about — losses, not all volatility.
- ✓ Doesn't penalise positive upside — lets strong returns shine through without distortion.
- ✓ More aligned with behavioural realities — avoids overreacting to benign fluctuations.
- ✓ Ideal for drawdown-focused, goal-based, or capital-preservation strategies.
- ✓ Makes it easier to evaluate downside-skewed strategies on their own terms.
Limitations
- ✗ Can overstate performance when there’s little downside deviation.
- ✗ Ignores the shape or risk of wild upside swings — not always desirable.
- ✗ Highly sensitive to the target return — small changes shift the outcome significantly.
- ✗ Assumes downside risk behaves predictably — which may not hold in tail-risk events or skewed distributions.
- ✗ Doesn’t account for fees or trading costs, results must be interpreted in context.
8. Alternatives to the Sortino ratio
While the Sortino ratio offers a sharper focus on downside risk than Sharpe, it’s still just one lens.
Different situations — like comparing against a benchmark, managing tail risks, or evaluating consistency — may call for different metrics.
Here are some commonly used alternatives and complements to the Sortino ratio:
The original and most widely used risk-adjusted return measure. Penalises all volatility — not just downside.
- What it measures: Return per unit of total volatility
- Best for: Broad comparisons where symmetrical risk matters
- Key limitation: Treats upside and downside fluctuations equally
Focuses on return relative to
maximum drawdown
The largest observed peak-to-trough drop in portfolio value over a period.
. Ideal for assessing downside risk over longer horizons.
- What it measures: Return divided by worst historical drawdown
- Best for: Comparing downside-resilient strategies over time
- Key limitation: Sensitive to outliers — one deep loss can skew the ratio
Measures how much active return a manager generates for each unit of tracking error against a benchmark.
- What it measures: Excess return over benchmark per unit of deviation
- Best for: Comparing actively managed funds to passive alternatives
- Key limitation: Only meaningful with a relevant benchmark
Looks at the full distribution of returns — comparing the probability-weighted gains and losses above a threshold.
- What it measures: Ratio of gains to losses above a set return level
- Best for: Analysing skewed or non-normal return patterns
- Key limitation: More complex to calculate and interpret
9. Interactive calculator
Use this tool to calculate the Sortino ratio of your investment portfolio and understand how well it's delivering returns relative to downside risk.
Enter your annual returns and target return to assess the risk-adjusted performance of your portfolio based on downside deviation.
Enter your values to calculate the Sortino ratio.