A few weeks ago I created a Model Investment Portfolio and I have been tracking it ever since. This past week the portfolio generated a total return of 7.77%, outpacing S&P 500 Index weekly returns of 5.98%. Since its inception on 9/23/11 the NWP portfolio has provided a return of 8.82% and the S&P 500 Index provided a return of 7.76% over the same period.

Thus far the use of levered-ETF to magnify exposures to U.S. large cap and emerging market equities has provided the boost in returns I was hoping to receive. However, the downside to this approach is increased volatility. The model portfolio has an annualized volatility of returns of 33.7% while the S&P 500 has been less volatile at 23.3%.

Given the wide disparity in volatility I need to find a way to compare “apples to apples”. In other words, How do I determine if I am being paid enough in terms of returns to compensation me for the extra risk? (Assuming we view volatility as an adequate measure of risk)

This week I am focusing on one metric (there are many others) known as the Sharpe Ratio to help me compare my portfolio performance to indices. The Sharpe Ratio is a relatively simple way to measure risk-adjusted returns. Here is the formula:

**Sharpe** = *(Portfolio Return – Risk free return) / Standard deviation of returns*.

I used the 10-year U.S. treasury rate as a proxy for the risk free rate of return, which is currently at a rate of 1.93%.

At this point , my portfolio is underperforming on a relative basis because the model portfolio has a lower Sharpe Ratio of 1.07 vs. The S&P 500 ratio of 1.36. BUT, I am still happy with the portfolio performance for three main reasons 1) I applied moderate leverage in the portfolio expecting outsized risk, so I am not that surprised. 2) My portfolio is not meant to be perfectable comprable to the S&P 500. For example, the S&P 500 does not have any fixed income or commidities holdings, whereas my portfolio has significant positions in these asset classes. 3) The model portfolio has only been live for 3 weeks; give it a chance man!.

Here is the portfolio as it stands today (10/14/11). I will likely liquidate the leveraged ETFs if the S&P 500 reach 1,275 before year end. At that point I would expect another correction so I plan to hold the cash proceeds and will buy in again at $1,180.