What is risk-adjusted return?

Risk-adjusted return is defined as the measure of return relative to the risk taken to achieve that return. This concept acknowledges that different investments carry varying levels of risk, and it emphasizes the importance of comparing performance not just by the return generated, but also by the amount of risk that was undertaken to achieve that return.

By considering both return and risk, investors can make more informed decisions, as a higher return does not necessarily mean a better investment if it comes with proportionately higher risk. For instance, if two investments yield similar returns but one involves significantly less risk, that investment may be considered superior from a risk-adjusted return perspective.

In contrast, a measure of return without considering risk fails to provide a complete picture of an investment’s performance. Simply calculating average returns without adjusting for risk can lead to misleading conclusions about which investment is genuinely better. Similarly, the average return of all investments lacks the individual context needed to assess risk properly. A classification of investment stability does not directly relate to returns, and it does not incorporate the necessary comparative aspect of risk involved in investments.