Evaluating Investments by the Inventor of the Sharpe Ratio

Nobel Prize-winning economist William Sharpe gave an interesting interview to AAII. He makes several points that all investors should note. Sharpe developed a statistic that’s now called the Sharpe ratio. He said he was looking for a number to consider if you only can look at one number to evaluate an investment. Now, he says that with all the computing power we have today, you should try to use only one number of piece of data to evaluate an investment. Another point: The Sharpe ratio and other data are historic. You should be more concerned about future return and risk, and historic data is an imperfect tool for evaluating that.

There’s a famous saying: If you torture a body of data long enough, it’ll confess to anything you want. People have looked for so many ways to beat the market using past data that of course they found ways that would have worked. But I would be much more comfortable if there were a story as to why, if everybody knew this history, it would still work. Most of these arguments don’t have such a story.