What is ROI & how do you calculate it?
November 2, 2023 4 min read
Whether you’re just starting to purchase stocks or you’ve been making trades for a few years, it’s important to understand the value of your investments. You can do that by calculating your return on investment (ROI), a metric that shows how much profit or loss your assets have earned.
Here’s what to know about ROI and how to calculate it.
ROI, or return on investment, helps you judge the performance of a particular investment.
There’s an equation to help you calculate ROI, which is expressed as a percentage. This helps you compare ROI across different assets and asset classes.
You may decide to take on riskier investments to earn a higher return. But diversifying your portfolio can help offset some of that risk.
What is return on investment (ROI)?
When you put money into an asset, such as a stock or bond, the goal is to grow your money as much as possible. You may potentially earn a profit, but there’s also the potential for losing your money. ROI allows you to check the performance of the asset by measuring profit or loss. This information may help guide your future investment decisions.
How to calculate ROI
There are a few steps involved in calculating ROI. You’ll start by identifying two numbers:
The amount of money you invested and any other costs associated with the trade, such as investing fees and capital gains taxes
The present value of your investment
Subtract the amount you invested from the present value of your investment and divide the result by the amount you invested. The last step is multiplying the result by 100 so your ROI is represented as a percentage.
The ROI equation looks like this:
Example of an ROI calculation
Let’s say you invested $1,000 in a particular stock a year ago. That’s the cost of your investment, or the amount you put in. Today, you sell your shares for $1,100, which is the present value of your stock. To simplify this example, we’ll leave out fees and capital gains taxes.
Here’s how to calculate your ROI for this hypothetical investment:
Your ROI is 10% in this simplified example.
What is the average return on investment?
The value of your investments can fluctuate moment by moment. But because ROI is expressed as a percentage, it can help you compare investment performances across different asset classes. Then you can determine which gives the highest yield.
Stocks: When you buy a stock, you get partial ownership in a company. Stocks have returned 13.8% on average over the past decade and about 10% over the past 100 years. But because the stock market can be volatile, investors may receive more in some years and less in others.
Bonds: A bond is essentially a loan you make to a government or company. This type of investment has had an average ROI of 1.6% over the past decade.
Real estate: Some real estate investment options include purchasing a home and buying shares in a real estate investment trust. Real estate has averaged an 8.8% return over the past decade.
CDs: A certificate of deposit, or CD, is a type of savings account where you agree to lock up your money for a certain period of time. The bank pays you interest in exchange. Over the past decade, one-year CDs have had an ROI of 0.38% on average. But some CDs are now providing a yield around 4.75% or even higher.
What is a good return on investment?
A “good” return on investment is subjective, so it depends on the individual investor. Every person has a different risk tolerance and set of financial goals.
Many professionals look to the average ROI on a particular investment to assess a good return. For instance, the S&P 500 has returned 10% on average over the past century.
What is risk and return on investment?
Risk is the potential to lose money when you make an investment decision. There’s no such thing as a guaranteed investment, so all investments come with some level of risk. For instance, the value of your investment can fluctuate, or the company you invest in may go out of business. You also take on the risk that no one will purchase your investment at a certain price when you’re looking to sell it.
But investors are willing to accept risk because riskier investments typically provide a higher profit.
One way to minimize risk is through diversification, where you spread your money across different types of investments. Some assets could perform well, while others may do poorly. But their positions could reverse next year or even within the next few months. This practice is designed to help reduce the volatility of your portfolio over time.
ROI in a nutshell
Calculating ROI can help you judge the performance of the investments in your portfolio. You can compare ROIs on all your assets to figure out which offer the highest returns. This information may inform your future goals. If you’re saving for retirement, for example, you can determine the ROI you’re getting and figure out if you need to adjust your strategy.