Rate of Return on Investment (ROI) Calculator
Understanding Rate of Return on Investment (ROI)
The Rate of Return on Investment (ROI) is a performance measure used to evaluate the efficiency or profitability of an investment or to compare the efficiency of a number of different investments. ROI is typically expressed as a percentage and is calculated by dividing the net profit from an investment by its cost.
Formula:
The basic formula for ROI is:
ROI = ((Final Value of Investment – Initial Investment) / Initial Investment) * 100
To annualize the ROI over a specific time period, you can use the following formula:
Annualized ROI = (((Final Value of Investment / Initial Investment) ^ (1 / Time Period)) – 1) * 100
Key Components:
- Initial Investment: This is the total cost incurred to acquire the investment. This includes purchase price, transaction fees, and any other associated expenses.
- Final Value of Investment: This is the current market value or the selling price of the investment. It represents how much the investment is worth at the end of the period.
- Time Period: This is the duration for which the investment was held, usually measured in years. It's crucial for understanding the annualized return.
Why is ROI Important?
ROI is a vital metric for investors because it provides a clear and concise way to gauge how well an investment has performed. It helps in:
- Performance Evaluation: Determining the profitability of an investment.
- Comparison: Allowing investors to compare different investment opportunities side-by-side, regardless of their initial size.
- Decision Making: Assisting in making informed decisions about where to allocate capital.
- Measuring Efficiency: Understanding how efficiently capital is being used to generate profits.
Example Calculation:
Let's say you invested $10,000 in a stock (Initial Investment). After 2 years (Time Period), the stock is now worth $12,000 (Final Value of Investment).
Simple ROI:
ROI = (($12,000 – $10,000) / $10,000) * 100
ROI = ($2,000 / $10,000) * 100
ROI = 0.20 * 100 = 20%
Annualized ROI:
Annualized ROI = ((($12,000 / $10,000) ^ (1 / 2)) – 1) * 100
Annualized ROI = ((1.2 ^ 0.5) – 1) * 100
Annualized ROI = (1.0954 – 1) * 100
Annualized ROI = 0.0954 * 100 = 9.54% (approximately)
This means your investment grew by 20% over two years, averaging an annual return of about 9.54%. Understanding both the total return and the annualized return provides a comprehensive view of your investment's performance.