Return on Investment (ROI) measures the gain or loss from an investment relative to its cost. It's one of the most commonly used financial metrics in business, investing, and personal finance — and the formula is elegantly simple.
The ROI Formula
ROI = (Net Profit ÷ Cost of Investment) × 100. Net profit is the final value of the investment minus the original cost. If you invest $5,000 and it grows to $7,500, your net profit is $2,500. ROI = (2,500 ÷ 5,000) × 100 = 50%.
Worked Examples
- Buy stocks for $10,000, sell for $13,500: ROI = (3,500 ÷ 10,000) × 100 = 35%
- Spend $500 on a marketing campaign, generate $2,000 revenue: ROI = (1,500 ÷ 500) × 100 = 300%
- Buy property for $200,000, sell for $180,000: ROI = (−20,000 ÷ 200,000) × 100 = −10%
Annualized ROI
Simple ROI doesn't account for time. A 50% ROI over 10 years is very different from a 50% ROI over 1 year. Annualized ROI = ((1 + ROI)^(1/years) − 1) × 100. A 50% ROI over 5 years is equivalent to about 8.45% per year — a reasonable stock market return.
Limitations of ROI
- Ignores risk — a high ROI from a speculative investment may not justify the risk taken
- Ignores time — doesn't compare investments of different durations fairly without annualizing
- Ignores cash flows — doesn't capture intermediate dividends or income unless included in net profit
- Easy to manipulate — unscrupulous promoters can cherry-pick time periods to show favorable ROI
ROI is a useful starting point but should never be the only metric. Always ask: what was the risk, over what time period, and what were the opportunity costs?
