Return On Investment (ROI) (2024)

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Return on investment (ROI) is a metric used to understand the profitability of an investment. ROI compares how much you paid for an investment to how much you earned to evaluate its efficiency. Let’s take a look at how it’s used by both individual investors and businesses.

What Is ROI?

When you put money into an investment or a business endeavor, ROI helps you understand how much profit or loss your investment has earned.

Return on investment is a simple ratio that divides the net profit (or loss) from an investment by its cost. Because it is expressed as a percentage, you can compare the effectiveness or profitability of different investment choices.

Read More: Check out our ROI calculator

ROI is closely related to measures like return on assets (ROA) and return on equity (ROE).

How to Calculate ROI

To calculate return on investment, divide the amount you earned from an investment—often called the net profit, or the cost of the investment minus its present value—by the cost of the investment and multiply that by 100. The result should be represented as a percentage. Here are two ways to represent this formula:

ROI = (Net Profit / Cost of Investment) x 100

ROI = (Present Value – Cost of Investment / Cost of Investment) x 100

Let’s say you invested $5,000 in the company XYZ last year, for example, and sold your shares for $5,500 this week. Here’s how you would calculate your ROI for this investment:

ROI = ($5,500 – $5,000 / $5,000) x 100

Your return on investment in company XYZ would be 10%. This simple example leaves out capital gains taxes or any fees involved in buying or selling the shares, but a more realistic calculation would factor those into the cost of the investment.

The percentage figure delivered by the calculation is ROI’s superpower. Instead of a specific dollar amount, you can take this percentage and compare it to the ROI percentage of other investments across different asset classes or currencies to determine which gives the highest yield.

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How to Use ROI

ROI may be used by regular investors to evaluate their portfolios, or it can be applied to assess almost any type of expenditure.

A business owner could use ROI to calculate the return on the cost of advertising, for instance. If spending $50,000 on advertising generated $750,000 in sales, the business owner would be getting a 1,400% ROI on the ad expenditure. Similarly, a real estate owner mulling new appliances might consider the ROI from two different renovation options, factoring in cost and potential rent increases, to make the right choice.

Just keep in mind that ROI is only as good as the numbers you feed into your calculation, and ROI cannot eliminate risk or uncertainty. When you use ROI to decide on future investments, you still need to factor in the risk that your projections of net profits can be too optimistic or even too pessimistic. And, as with all investments, historical performance is no guarantee of future success.

What Is a Good ROI?

According to conventional wisdom, an annual ROI of approximately 7% or greater is considered a good ROI for an investment in stocks. This is also about the average annual return of the , accounting for inflation.

Because this is an average, some years your return may be higher; some years they may be lower. But overall, performance will smooth out to around this amount.

That said, determining the appropriate ROI for your investment strategy requires careful consideration rather than a simple benchmark. The S&P 500 may not be appropriate for the level of risk you’re willing to take on or the asset class you’re investing in, for instance. To calculate the ROI that’s good for you, ask yourself the following questions:

  • How much risk can I afford to take on?
  • What will happen if I lose the money I invest?
  • How much profit do I need for this investment to take on the prospect of losing money?
  • What else could I do with this money if I don’t make this investment?

Limitations of ROI

ROI is not without limitations. First and foremost, ROI does not take time into account.

If one investment had an ROI of 20% over five years and another had an ROI of 15% over two years, the basic ROI calculation cannot help you determine which investment was best. That’s because it doesn’t take into account compounding returns over time.

Annualized ROI can help avoid this limitation. To calculate annualized ROI, you need to employ a little bit of algebra. The value n in the superscript below is key, as it represents the number of years the investment is held.

Annualized ROI = {[1 + (Net Profit / Cost of Investment)] (1/n) – 1} x 100

If you bought a portfolio of securities worth $35,000, and five years later your portfolio was worth $41,000, you’d have earned an annualized ROI of 3.22%. The formula would look like this:

Annualized ROI = {[1 + (6,000 / 35,000)] (1/5) – 1} x 100 = 3.22%

Accurate ROI calculations depend on factoring in all costs, not merely the initial cost of the investment itself. Transaction costs, taxes, maintenance costs and other ancillary expenditures need to be baked into your calculations.

Finally, an ROI calculation that depends on estimated future values but does not include any kind of assessment for risk can be a problem for investors. It is easy to be tempted by high potential ROIs. But the calculation itself does not give any indication of how likely that kind of return will be. This means investors should tread carefully.

The Bottom Line

ROI is an understandable and easily calculated metric for determining the efficiency of an investment. This widely used calculation allows you to compare apple-to-apples among investment options.

But ROI cannot be the only metric investors use to make their decisions as it does not account for risk or time horizon, and it requires an exact measure of all costs. Using ROI can be a good place to start in evaluating an investment, but don’t stop there.

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Return On Investment (ROI) (2024)

FAQs

Return On Investment (ROI)? ›

Return on Investment (ROI) is a popular profitability metric used to evaluate how well an investment has performed. ROI is expressed as a percentage and is calculated by dividing an investment's net profit (or loss) by its initial cost or outlay.

What is a good return on investment ROI? ›

General ROI: A positive ROI is generally considered good, with a normal ROI of 5-7% often seen as a reasonable expectation. However, a strong general ROI is something greater than 10%. Return on Stocks: On average, a ROI of 7% after inflation is often considered good, based on the historical returns of the market.

How do you calculate return on investment ROI? ›

Return on investment (ROI) is an approximate measure of an investment's profitability. ROI is calculated by subtracting the initial cost of the investment from its final value, then dividing this new number by the cost of the investment, and finally, multiplying it by 100. ROI has a wide range of uses.

What does 20% ROI mean? ›

ROI is a calculation of the monetary value of an investment versus its cost. The ROI formula is: (profit minus cost) / cost. If you made $10,000 from a $1,000 effort, your return on investment (ROI) would be 0.9, or 90%. This can be also usually obtained through an investment calculator.

What is ROI with an example? ›

ROI = Net Profit / Cost of Investment

Example, an investor purchases ₹1,00o worth of shares and sells the stock two years later for ₹1,200. The net profit from the expenses would be ₹200, and the Return on Investment can be calculated as below. So, in the above example, the Return on Investment will be 20%.

How much money do I need to invest to make $1000 a month? ›

A stock portfolio focused on dividends can generate $1,000 per month or more in perpetual passive income, Mircea Iosif wrote on Medium. “For example, at a 4% dividend yield, you would need a portfolio worth $300,000.

What is a realistic return on investment? ›

• A good return on investment is generally considered to be around 7% per year, based on the average historic return of the S&P 500 index, adjusted for inflation. • The average return of the U.S. stock market is around 10% per year, adjusted for inflation, dating back to the late 1920s.

What state has the highest ROI? ›

In-Depth Look at the States With the Best Taxpayer ROI
  • New Hampshire. New Hampshire is the state with the best taxpayer return on investment, which is due in large part to the fact that it has no state income tax. ...
  • Florida. ...
  • South Dakota.
Mar 19, 2024

What is the difference between ROI and ROE? ›

ROI measures if it's worth pursuing a revenue-generating activity, and ROE measures your company's profitability. Both figures are an indication of the overall financial health and performance of your company. You will learn a lot about your company from looking at these metrics, and so will (potential) investors.

What is a good ROI for rental property? ›

In general, a good ROI on rental properties is between 5-10% which compares to the average investment return from stocks. However, there are plenty of factors that affect ROI. A higher ROI often also comes with higher risks, so it's important to compare the reward with the risks.

What is a good ROI for a small business? ›

Common multiples for most small businesses are two to four times SDE. This equates to a 25% to 50% ROI. Common multiples for mid-sized businesses are three to six times EBITDA. This equates to a 16.6% to 33% ROI.

What are the disadvantages of ROI? ›

Disadvantages of ROI

Traditional ROI calculations do not take into account the time value of money, which could impact the profitability of an investment. ROI may overlook non-financial factors such as brand reputation, social impact, or customer satisfaction, which could influence the overall success of an investment.

Is 100% a good ROI? ›

Generally, the higher your ROI is over 100%, the better. If you have an ROI of just 100%, you essentially made your initial money back when accounting for costs.

What is a good ROI ratio? ›

While the term good is subjective, many professionals consider a good ROI to be 10.5% or greater for investments in stocks. This number is the standard because it's the average return of the S&P 500 , an index that serves as a benchmark of the overall performance of the U.S. stock market.

How to get ROI formula? ›

Shareholders can calculate the value of their stock investment in a particular company by use of this formula: ROI = (Net income + (Current Value - Original Value)) / Original Value * 100.

Is ROI calculated annually? ›

ROI can be calculated over any period of time, but it's most commonly calculated on an annual basis. This allows for easier comparison between different investments and provides a standardized measure of performance.

Is 30% ROI good? ›

Is 30% Good ROI? An ROI of 30% can be good, but it can depend on how long your ROI has been at 30% in previous years. A 1-year ROI of 20% compared to 3-years of a 30% ROI can be considered a better investment.

Is 20% ROI high? ›

A 20% return is possible, but it's a pretty significant return, so you either need to take risks on volatile investments or spend more time invested in safer investments.

Is a 25% ROI good? ›

Overall, a 25% yearly return on investment is a strong performance, but it's important to evaluate the investment's risks and historical performance before making any investment decisions.

Is 10% return on investment realistic? ›

Usually the implication is that they can expect, over a long time, a 10% return. Fortunately some ask, with some doubt, "Is a 10% return really reasonable?" It is not. While the average growth or return in the market (e.g., the S&P 500) is about 10%*, investors over time do not see that.

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