How to Calculate the Sortino Ratio
- 1). Review the formula. The Sortino Ratio = (Compound Period Return - MAR) / Downside Risk.
- 2). Calculate Compounded Period Return. The compound period return = (1+Total return)^(1/N) - 1. Where N is the number of periods and total return is the return over a certain time period. A 10% return over 5 years would yield a compounded period return of 1.5^(1/5) - 1. A compounded 'monthly' return would change the number of periods from 5 to 60.
- 3). Calculate the minimum average return (MAR). This is up to the investor. It can be 0 percent or the current risk free rate divided by 12. 10 year treasuries can be used as a proxy for the risk free rate.
- 4). Calculate downside deviation. If you are familiar with quantitative methods and statistics, this is computed like a standard deviation, however, it ignores all positive results. The equation can be calculated in MS Excel.
- 5). Start by subtracting MAR from each period's return. You only want the negative values, so if the number is positive, adjust to 0.
- 6). Square the period returns and sum all for a total.
- 7). Divide the sum by the total number of periods and then take the square root of this number. This is the Sortino Ratio. Again, this is equivalent to a standard deviation equation with no positive return results.
