Return on Investment (ROI)
A performance measure used to evaluate the efficiency or profitability of an investment, expressed as a percentage.
Return on Investment (ROI) is a universal financial metric used to evaluate the profitability of an investment or to compare the efficiency of several different investments.
Because it is expressed as a percentage rather than a raw currency amount, ROI allows investors to instantly compare the success of a $100 stock purchase against a $1,000,000 real estate acquisition on an equal mathematical playing field.
The Formula
The standard formula for calculating ROI is:
ROI = [(Current Value of Investment - Cost of Investment) / Cost of Investment] × 100
Alternatively:
ROI = (Net Profit / Cost of Investment) × 100
Example
If you buy shares in a company for $1,000 and later sell them for $1,200, your net profit is $200.
ROI = ($200 / $1,000) × 100 = 20%
Limitations
While ROI is incredibly useful for its simplicity, its biggest flaw is that it does not account for the Time Value of Money. A 20% ROI achieved over 1 week is an exceptional return. A 20% ROI achieved over 10 years is a terrible return (as it likely failed to beat inflation). Therefore, for long-term investments, metrics like CAGR or IRR (Internal Rate of Return) are often preferred over simple ROI.