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- Return on investment (ROI) is an important metric for gauging the performance of an investment.
- When calculating return on investment, make sure to consider all your costs and any income that the investment may have generated.
- If you’ve held an investment for multiple years, it’s important to find your annualized rate of return.
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Whether you invest in the stock market, real estate, or your own small business, return on investment is an important metric for you to keep any eye on. ROI calculations make it easy to compare investment options. They can also help you decide whether to take or skip an investment opportunity.
ROI is expressed as a percentage or ratio. In this guide, we’ll take a look at what you need to consider when you’re trying to calculate your return on investment and provide some simple formulas that you can use.
How to calculate return on investment
1. Realize that return on investment can be positive or negative
ROI calculations are meant to show how the sales price (or current value) of your investment compared to what you initially paid for it. For this reason, your ROI could be positive or negative.
Let’s say you bought one share of XYZ stock for $100. Later, you sell the stock for $120. That’s a positive ROI of 20%. However, if you ended up selling your investment for $80, you’d have a negative ROI of -20% instead.
2. Consider how much you initially paid
Most investments aren’t as simple as the example given above. For instance, you’ll often have to pay a commission on stock or mutual fund trades.
When you buy real estate, your actual investment cost will usually be higher than the purchase price because you’ll have real estate agent commissions and closing costs.
When you’re calculating your Return on Investment, you want to take as many "hidden" costs into consideration as possible.
3. Don’t forget any ‘hidden’ income you’ve earned from the investment
Does your stock pay a dividend each quarter? If so, that needs to be included in your ROI calculations. Have you been receiving rent payments on your investment property? You’ll want to consider that as well.
The more information that you’re able to include on both the expense and income side of your ROI formula, the more true the number will be.
4. Divide the overall growth by the initial investment
Ok, now we’re ready to take a look at a simple ROI formula.
ROI = Net Income or Investment Gain / Cost of Investment
Your ROI can either be realized or unrealized, depending on whether or not you’ve sold the investment or are still holding it.
- If you’ve sold your investment, you’ll use net income as the first number in your formula.
- Otherwise, you’ll use your current investment gain based on what the investment is currently worth.
Let’s say you bought a property for $250,000 (all in, including agent commissions and closing costs) and three years later sold it for $300,000.
This is what the ROI formula would look like for that example.
ROI = ($300,000 – $250,000) / $250,000
ROI = $50,000 / $250,000
ROI = 20% (.20)
5. Consider how long you’ve held your investment to discover your annualized return
While simple Return on Investment formulas can be helpful, they are also limited. They don’t take into account how long you’ve held the investment.
Let’s say you’ve bought a stock for $200 and after one year it was worth $220. That would be a 10% ROI and you’d probably be pleased. However, you’d be sorely disappointed with that total return over a 10-year period.
You’d be disappointed because you’d (rightfully) expect your investment growth to compound over time. And that’s why most of us want to know want to see the annualized return on our investments.
The annualized ROI formula is a bit more complicated. Here’s what it looks like.
Annualized ROI = (current value / cost) (1/years) – 1
Using our real estate example from above, here’s how we would plug in the numbers to the annualized ROI formula. The key thing to remember here is that we said that the property had been held for three years, so that’s the number that we’ll put in where "years" is written above.
Annualized ROI = ($300,000 / $250,000)1/3 -1
Annualized ROI = (1.2)1/3 -1
Annualized ROI = 1.063 -1
Annualized ROI = .063
Annualized ROI = 6.3%
So now we see that our total 20% rate of return translates to an annualized return of around 6%. That’s a nice return, but not nearly as impressive.
Whenever you’ve held an investment for multiple years, you’ll want to use the annualized ROI formula. It gives you a truer sense of how well the investment has really performed.
6. Use an online tool if you’d rather not do the math yourself
Not a math fan? That’s OK. You don’t have to do all of these calculations yourself. There are lots of online tools and calculators that can help. With most online annualized return calculators (Bankrate has a good one), you just plug in your investment data it takes care of all the heavy lifting for you.
Also, if you’re trying to calculate your ROI on stock or mutual fund investments, you may not need to do any work at all. Most brokerage companies will calculate your total return and annualized ROI for you.
You should be able to find your ROI numbers on the next statement that you receive. Or, if you’d like to check your ROI today, try logging on to your brokerage’s online portal.
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