What is ROI?

ROI is an acronym that means return on investment. Typically expressed as a percentage, ROI shows how much profit or loss assets have earned compared to the original investment amount.

Whether you’re just starting to purchase stocks or you’ve been making trades for a few years, it’s a good idea to understand the value of your investments. This guide explains what to know about ROI and how to calculate it.

What you’ll learn:

• ROI helps you judge the performance of a particular investment and compare profitability across different assets and asset classes.

• There’s a formula for calculating ROI, which is expressed as a percentage.

• You may decide to take on riskier investments to earn a higher return. But diversifying your portfolio can help offset some of that risk.

ROI is important because it allows you to check the performance of your investments. And knowing an asset’s ROI may help guide your future investment decisions.

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.

You can calculate ROI using a formula:

ROI = ((Present value − Cost of investment) ÷ Cost of investment) × 100

To calculate ROI using the formula, start by identifying the figures for the following:

• The original amount of money you invested

• 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 then 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.

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:

((1,100 − 1,000) ÷ 1,000) × 100 = 10%

Your ROI is 10% in this simplified example.

The value of investments can fluctuate moment by moment, and average returns can vary depending on the type of asset and other factors. Because ROI is expressed as a percentage, average returns can help you compare investment performance across different asset classes. Then you can determine which gives the highest yield.

Here’s a look at some different types of investments and their average ROIs:

• Stocks: When you buy a stock, you get partial ownership in a company. Stocks have returned 12.8% on average over the past decade. 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 1.5% 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 a 4.2% 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 1.7% on average.

A good return on investment is subjective because every person has a different risk tolerance and set of financial goals. So, what’s considered a good ROI depends on the individual investor.

Many professionals look to the average ROI on a particular investment to assess a good return. For instance, the S&P 500 stock market index has returned 10% on average over the past century.

Risk is the potential to lose money when you make an investment decision. Investors are willing to accept risk because riskier investments typically come with the potential for higher ROI.

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.

One way to minimize risk is through diversification, in which 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.

A potential disadvantage of the ROI metric is that it doesn’t account for the timeline between the dates of purchase and sale. So the ROI figure may not tell the full story when comparing assets.

Another limitation of ROI is that it doesn’t account for inflation. A high ROI percentage may look appealing, but if inflation increased by a similar percentage during that period of investment, the actual ROI could be closer to zero.

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 help inform your future goals and investment decisions. 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.