Risk Adjusted Return: Meaning, Formula, Example And Importance

Key Takeaways: 
 

• Risk adjusted return is a useful method that helps balance the investment returns based on the risk taken. It ensures you don’t just run after high returns but also learn to balance them. 
   
• Learning how to calculate risk adjusted return allows customers to understand the difference between assets even if they face different risk levels. 
   
• The risk adjusted return calculation is essential for better decision-making about stocks, bonds, and portfolios. Meanwhile, the risk adjusted return on capital helps businesses in the same way. 
   
• Different tools, like risk adjusted return Sharpe ratio, allow investors to evaluate their progress and guide them toward smarter decisions. 

When we hear the word investment, the first thing that comes to each of our minds is big success and shoutouts. But in reality, not every investment can offer a big return; in fact, it can also transform into a big loss. The investment market comes with various risks; this is where investors use risk adjusted return calculation. 

It is simple, if we have a choice that one investment is offering 12% return while another is giving 8%. We all know what we will choose here, right? But what if I told you that 12% return also has a catch? You will need to spend hours in front of the screen, and you are going to face some uncertainties. Will you still choose it?

This is exactly why risk adjusted return matters. It provides you with clarity of your profits, like how much you earned and what took you to reach that. This is where you will understand whether the risk you took was worth it or not. 

If you also want to learn more about this method, we have a whole article written for you. You just need to scroll down and read it. Here, we will teach you the concept, logic, and decisions behind the risk adjusted return. 

What is a Good Risk Adjusted Return?

So you have heard about the risk adjusted return? What do you think about this method? Let me tell you what I think.

I think of risk adjusted return as a reality check. It is an investment tool that is not impressed by higher returns alone. It makes you ask yourself, do you actually deserve this? Interesting. 

As per some renowned institutions, the risk adjusted return evaluates the amount of return an investment will generate. Also, while keeping in mind how much risk you might face to reach that return price. This can also be expressed as a ratio that indicates better performance where the value is higher. 

Most investors feel safe with choosing the investment that offers a higher return, but in reality, one should choose an investment that is stable. This is where investors should use this tool. Investors rely on returns that mislead them in choosing the wrong option. High returns might look good in numbers, but they may not be as sustainable as they look. 

How to Calculate Risk Adjusted Return

Instead of trusting words, we will show you how to calculate risk adjusted return practically. Once you understand the calculations, it will actually make sense in your head. 

Below are some of the methods through which you can also calculate the risk adjusted return: 

Method	Explanation	Formula
Risk Adjusted Return Sharpe Ratio	This is used to measure the amount of extra return you earned for the total risk taken.

Components explained: 

1. Rp = Portfolio Return 

In the above table, the most used and common method is risk adjusted return Sharpe ratio. This is mostly used by investors to evaluate the returns. 

Bonus Tip: The risk adjusted return on capital (RAROC) is an important financial metric for banks and investors. As per 2025-26 data, the RAROC has a strong financial figure for institutions of 12-15%.