Financial Word of the Day: Information Ratio
- Larry Jones
- Jan 21
- 2 min read
Most investors know how to measure returns.
Fewer know how to measure skill.
That’s where today’s financial word of the day comes in: Information Ratio (IR)
The Information Ratio measures how consistently an investment manager or portfolio beats a benchmark after adjusting for risk.
In simple terms, it answers this question: Are you outperforming the market because of real skill—or just luck?
The Simple Definition of Information Ratio
The Information Ratio compares a portfolio’s excess return (how much it beats a benchmark) to the consistency of that outperformance.
Formula (don’t panic): Information Ratio = (Portfolio Return – Benchmark Return) ÷ Tracking Error
You don’t need to memorize that.
What matters is this:
A higher Information Ratio means better, more reliable outperformance
A lower Information Ratio means inconsistent or random results
Why the Information Ratio Matters
Anyone can beat the market once.
The real question is: Can they do it consistently?
The Information Ratio helps investors:
Evaluate active managers
Compare funds with the same benchmark
Separate repeatable strategy from one-hit wonder performance
It’s especially useful when:
Two funds have similar returns
One claims “active management”
You want proof—not marketing
In short, the Information Ratio measures how efficiently risk is being used to add value.
A Simple Example of Information Ratio
Let’s say:
A mutual fund beats the S&P 500 by 2% per year
But the performance swings wildly from year to year
That fund might look impressive on paper.
Now compare it to another fund:
Beats the same benchmark by 1.5%
Does it steadily, year after year
The second fund may have a higher Information Ratio, even with slightly lower returns—because its outperformance is more predictable and controlled.
Consistency wins.
How Information Ratio Shows Up in Real Life
You might hear it used like this: “This manager’s returns aren’t flashy, but their Information Ratio is strong—which tells me their process actually works.”
Or: “That fund beat the market last year, but the Information Ratio suggests it was more luck than strategy.”
Smart investors look beyond returns and ask:
How repeatable is this performance?
What risks are being taken to get it?
One Caution
A high Information Ratio doesn’t guarantee future success.
Markets change. Strategies stop working.
But it does help you ask better questions—and avoid chasing hype.
Bottom Line
The Information Ratio helps you evaluate skill, not just results.
It’s a reminder that:
Beating the market once is easy
Beating it consistently is rare
And measuring how returns are achieved matters just as much as how much
If you want to invest smarter—not louder—the Information Ratio belongs in your financial vocabulary.
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