ROI (Return on Investment) is a performance measure used to evaluate the efficiency or profitability of an investment. It directly measures the amount of return on a particular investment, relative to the investment's cost.
ROI is expressed as a percentage and is commonly used to compare the efficiency of different investments. A higher ROI means more profitable investment relative to its cost.
Calculating ROI is straightforward and involves comparing the gain or loss from an investment to its cost:
Annualized ROI: ROI = [(Final Value / Initial Investment)^(1/n) - 1] × 100%
Where: n = number of years
Problem: You invested $10,000 in stocks and sold them 3 years later for $14,500. What is your ROI?
Solution:
A "good" ROI depends on the investment type and risk level. Stock market investments typically aim for 7-10% annual returns, real estate may target 8-12% annually, while safer investments like bonds might yield 3-5%. Compare ROI to benchmarks in the same asset class.
ROI shows the total return over the entire investment period, while annualized ROI converts that return to an average yearly rate. Annualized ROI is useful for comparing investments with different time periods.
ROI doesn't account for the time value of money, risk levels, or ongoing costs. It also doesn't consider how long the money was invested. A 50% ROI over 10 years is different from 50% over 1 year. Use ROI alongside other metrics for complete analysis.