Sterling ratio

The Sterling Ratio is a way to measure how good an investment is compared to the amount of risk taken. It's like playing a game where you want to get the most points (a good investment return) without getting hurt (taking on too much risk).

Imagine if you and your friend were playing a game to see who could jump the furthest. You both take turns jumping over a rope, and whoever jumps farthest gets a treat. But jumping far comes with a risk – if you trip over the rope, you might get hurt. So you have to decide how much more risk you're willing to take on in order to jump farther.

In investing, the risk is measured by something called the downside deviation. This means how much the investment goes down when things go bad. The Sterling Ratio compares the investment return to the downside deviation to see if the investment is worth the risk.

For example, let's say you invest in a stock that returns 10% in a year. That sounds pretty good, right? But if that stock also has a downside deviation of 20%, that means it could lose you 20% of your investment in a bad year. The Sterling Ratio would be calculated by dividing the 10% return by the downside deviation of 20%, giving you a ratio of 0.5.

The higher the Sterling Ratio, the better the investment is, because it means you're getting more return for the amount of risk you're taking on. So just like in the jumping game, you want to find the investment that gets you the most points (return) while minimizing the risk of getting hurt (downside deviation).