Risk Protocols
Sharpe Ratio, asset correlation, volatility, and inflation hedging — the frameworks that separate an efficient return from a lucky one.
Sharpe Ratio
The Sharpe Ratio measures how much excess return a portfolio generates for each unit of volatility it takes on. A higher Sharpe Ratio suggests a more efficient risk-adjusted return, while a lower one signals that gains may have come from taking on excessive risk.
It's calculated by subtracting the risk-free rate from a portfolio's return, then dividing by the portfolio's standard deviation.
< 1.0
Below Average
1.0 – 2.0
Good
> 2.0
Excellent
Asset Correlation
Correlation is scored from -1 to +1. Combining assets with low or negative correlation is the mechanism behind effective diversification.
+1.0
Perfect Positive Correlation
Assets move in the same direction, at the same time. Offers no diversification benefit.
0.0
No Correlation
Asset movements are unrelated to one another, offering meaningful diversification.
-1.0
Perfect Negative Correlation
Assets move in opposite directions, offering the strongest diversification effect.
Inflation Hedging
Inflation erodes the real value of cash and fixed-income returns over time. Equities, REITs, and certain inflation-linked bonds have historically served as partial hedges, since their income and value can adjust as prices rise.
A framework built with inflation in mind weighs nominal returns against real, after-inflation returns before drawing conclusions.
Portfolio Volatility
Longer horizons can typically absorb more short-term volatility.
Combining uncorrelated assets can reduce overall portfolio swings.
Periodic rebalancing keeps allocation drift and risk exposure in check.
Put It Together
Head back to Portfolio Frameworks to see how these risk concepts show up across different allocation structures.