The Sharpe Ratio and Long-Run Investment Decisions

Abstract

We investigate the empirical relationship between the Sharpe ratio and the investment horizon for portfolios of small stocks, large stocks, and corporate bonds. Sharpe ratios are calculated for holding periods of one through 25 years using returns generated by a simulation procedure that preserves serial correlation present in actual returns. We show that relative portfolio rankings vary with the investment horizon and portfolio rankings for autocorrelated returns are different from those for independent returns. Our results indicate that Sharpe ratios computed by investment advisory services such as Morningstar Mutual Funds that are based on short-term return intervals must be interpreted with care by long-term investors.