What is Return on Investment (ROI)?
Return on Investment (ROI) is a widely used financial metric that measures the profitability or efficiency of an investment relative to its initial cost. Whether you are buying stocks, starting a marketing campaign, or purchasing real estate, ROI tells you precisely how much value you gained (or lost) on your initial capital.
How to Calculate ROI
Calculating your basic ROI requires only two numbers: the Amount Invested and the Amount Returned (current value or final sale price). The standard ROI formula is as follows:
- Net Profit = Amount Returned - Amount Invested
- ROI (%) = (Net Profit / Amount Invested) × 100
What is Annualized ROI?
While standard ROI measures your total growth, it ignores the time it took to get there. For example, a 20% return over one year is excellent, but a 20% return over ten years is poor.Annualized ROI levels the playing field by calculating the equivalent geometric average return per year. This is crucial for comparing investments held for different lengths of time.
What is a "Good" ROI?
A "good" ROI depends entirely on your risk tolerance and the asset class:
- Stock Market (S&P 500): Historically averages around 7% to 10% annualized ROI before inflation.
- Real Estate: Often targets 8% to 12% annual returns depending on leverage and rental yields.
- Savings Accounts & CDs: Generally offer much lower, but guaranteed and risk-free, returns (e.g., 2% to 5%).