Understanding Return on Investment (ROI)
Return on Investment (ROI) is a widely used financial metric that measures the probability of gaining a return from an investment. It is a ratio that compares the gain or loss from an investment relative to its cost. It is as useful in evaluating the potential return from a stand-alone investment as it is in comparing returns from several investments.
How to Calculate ROI
The basic formula for ROI is straightforward:
While this basic formula is great for simple calculations, it doesn't account for the time value of money. That's where Annualized ROI comes in, which tells you the average return per year over the life of the investment.
Why Annualized ROI Matters
A 50% ROI sounds fantastic, but if it took 10 years to achieve, that's an annualized return of just 4.14%—which is comparable to a high-yield savings account. Annualized ROI allows you to compare investments held for different periods on an apples-to-apples basis.