Quick answer: Standard deviation shows how much a fund’s returns swing around their average. A higher number means a bumpier ride. The Sharpe ratio shows how much return the fund earned above a risk-free rate for each unit of that swing:
Sharpe ratio = (Fund return − Risk-free rate) ÷ Standard deviation
A higher Sharpe ratio means the fund was paid better for the risk it took. These numbers are only useful for comparing similar funds over the same period. They don’t predict future returns.
Last updated: 9 November 2026
Why returns alone aren’t enough
Say two flexi cap funds both returned about 15% a year over the past 3 years:
- Fund A rose steadily, with its worst fall about 12%.
- Fund B got there with two falls of more than 25%.
If you’d have panicked and sold during Fund B’s falls, you’d never have earned its 15%. Standard deviation and the Sharpe ratio turn that difference into numbers.
What is standard deviation in a mutual fund?
Standard deviation (SD) measures how far a fund’s returns usually move away from their own average. Factsheets usually show it as an annualised figure based on the last 3 years of monthly returns.
A rough way to read it: if a fund averages 14% a year with an SD of 12%, then in about two years out of three, its return has fallen somewhere between 2% and 26%. That’s the average plus or minus one SD. In the other years, it’s been even further from the average, in either direction.
| SD (annualised) | What it usually means | Typical of |
|---|---|---|
| Under 2% | Very stable | Liquid and overnight funds |
| 2–6% | Low swings | Short-duration debt, conservative hybrid |
| 8–14% | Moderate swings | Large cap, balanced advantage, index funds |
| 14–20%+ | Large swings | Mid cap, small cap, sectoral and thematic |
Rough ranges for orientation only. Check the fund’s own figure on its latest factsheet.
A higher SD isn’t bad in itself. Small cap funds are meant to be volatile. The question is whether the extra swing came with extra return. That’s what the Sharpe ratio measures.
What is the Sharpe ratio?
The Sharpe ratio was developed by economist William Sharpe. It asks one question: for every unit of volatility, how much extra return did the fund earn compared with a risk-free investment?
The risk-free rate is usually a short-term government security, such as a treasury bill yield. Each AMC states the rate it used in the factsheet footnotes.
A worked example
We’ll assume a risk-free rate of 6.5%.
| Return (3 years, annualised) | Standard deviation | Sharpe ratio | |
|---|---|---|---|
| Fund A | 14% | 12% | (14 − 6.5) ÷ 12 = 0.63 |
| Fund B | 16% | 18% | (16 − 6.5) ÷ 18 = 0.53 |
Illustrative figures.
Fund B earned 2 percentage points more a year. But it took 50% more volatility to do so, so each unit of risk earned less. Fund A did more with less.
That doesn’t automatically make Fund A “better”. If you have 15 years and can sit through big falls, Fund B’s higher return may suit you. The Sharpe ratio tells you how efficient a fund has been. Whether that suits you is a separate question.
What is a good Sharpe ratio?
Many websites say “above 1 is good, above 2 is great”. That rule comes from general finance and doesn’t work well for Indian mutual funds, because Sharpe ratios rise and fall with the market:
- After a strong 3-year rally, many equity funds show Sharpe ratios above 1.
- After a flat or falling period, the same funds may show 0.3 or even a negative number.
So use it relatively:
- Compare funds within the same category (large cap with large cap, small cap with small cap).
- Compare over the same period. Factsheets usually use 3 years.
- Check it against the category average, and see whether the fund stays above average across several periods.
A negative Sharpe ratio means the fund returned less than the risk-free rate over that period. You’d have been better off in treasury bills, at least for those 3 years.
Where to find these numbers
Look on the fund’s monthly factsheet, usually in a box labelled “Risk ratios” or “Quantitative data”. You’ll typically see:
| Ratio | What it tells you |
|---|---|
| Standard deviation | How much returns swing |
| Sharpe ratio | Return above the risk-free rate per unit of total volatility |
| Beta | How much the fund moves when its benchmark moves. A beta of 1.1 means it has tended to rise or fall about 10% more than the index |
| Portfolio turnover | How often the manager trades. Higher turnover means higher trading costs |
Some research sites also show the Sortino ratio, which counts only downward swings as risk, and alpha, the return above what the fund’s beta would predict. Both are useful, but standard deviation and the Sharpe ratio are the two most funds report.
5 mistakes people make with these ratios
- Comparing across categories. A liquid fund will almost always beat a small cap fund on Sharpe ratio. That says nothing useful about either.
- Using a single period. One good 3-year stretch isn’t consistency. Look at the ratio over different periods if your research tool allows it.
- Treating standard deviation as “how much I could lose”. SD measures swings in both directions. For downside risk, also look at the fund’s worst fall (maximum drawdown) in 2020 and in 2024–25.
- Forgetting it’s backward-looking. A fund’s portfolio, manager or strategy can change. Past volatility doesn’t guarantee future volatility.
- Picking a fund on one ratio. Combine it with expense ratio, rolling returns, fund manager tenure and how the fund fits your goal. Our checklist in How to Choose the Right Mutual Fund covers the rest.
How to use them in practice
When choosing between two or three funds in the same category:
- Shortlist on rolling returns and expense ratio.
- Compare standard deviation. Is one fund much bumpier than the others?
- Compare Sharpe ratio. Is it consistently near or above the category average?
- Check the fund’s worst fall against its benchmark’s worst fall.
- Ask yourself whether you could hold it through that worst fall without selling.
The last step matters most. The best risk-adjusted fund is no use if you sell it in a panic.
FAQs
What is the Sharpe ratio in simple words?
It’s the extra return a fund earned above a risk-free rate for each unit of volatility it took. Higher is better when you compare similar funds.
What is the formula for the Sharpe ratio?
(Fund return − Risk-free rate) ÷ Standard deviation of the fund’s returns, all for the same period.
Is a higher standard deviation bad?
Not on its own. It means more swings. Equity funds have higher SDs than debt funds by design. What matters is whether the return makes up for those swings.
Can the Sharpe ratio be negative?
Yes. That happens when the fund’s return over the period was lower than the risk-free rate.
Sharpe vs Sortino ratio: what’s the difference?
The Sharpe ratio counts all volatility as risk. The Sortino ratio counts only downside volatility, so it doesn’t penalise a fund for sharp rises.
Do index funds have a Sharpe ratio?
Yes. An index fund’s Sharpe ratio will be close to its index’s, minus the effect of costs and tracking error.
Mutual fund investments are subject to market risks. Read all scheme-related documents carefully. RingMoney is an AMFI-registered mutual fund distributor (ARN-320453). All examples are illustrative and don’t represent any scheme. Past performance doesn’t guarantee future returns.
Related reading: What Is XIRR in Mutual Funds? · Expense Ratio in Mutual Funds · Why the Best-Performing Fund Is Often a Bad Choice · Flexi Cap vs Index Fund
