High-return investments are appealing, but high-risk-adjusted-return investments are even more valuable. While risk can be challenging to measure, investors often use volatility as a proxy. In this approach, stocks with larger and more frequent price swings—both upward and downward—are considered riskier.
One way to measure a stock's risk-adjusted returns is to subtract the risk-free rate from its return over time. Then, divide that result by its volatility over that period. Investors know this as the Sharpe ratio, which shows how much return an investment generates for each unit of risk involved.
