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What Is ROI?
A performance measure to know about
Return on investment (ROI) is a performance measure used to evaluate the profitability of an investment or compare the efficiency of several different investments. ROI essentially tries to directly measure an investment’s return relative to its cost. ROI is a measure you should be familiar with as an investor.
The formula for ROI is as follows: ROI = (Current Value of Investment — Cost of Investment) / Cost Investment. ROI is expressed as a percentage. It has become a popular measure of performance because of its simplicity. For example, let’s say that you bought 100 shares of Company Z at $10 per share in November 2018. In November 2022, you decided to sell your shares, which are now $15 per share. The investment cost was $1,000 (100 shares * $10 per share). The current value of the investment is $1,500 (100 shares *$15 per share). Your ROI is 50% because ($1,500 — $1,000) / $1,000 = 50%.
One of the key limitations of ROI is that time is not specifically accounted for in the formula. Over four years, an ROI of 50% was earned. Dividing 50% by four gives an annualized ROI of 12.5%. For a more in-depth analysis of an investment, rate of return (RoR) is a measure that can be used alongside ROI to calculate net gain or loss over a specific time period.
ROI is a great way to quickly get an understanding of a return you can achieve on an investment. Like any simple performance measure, it has some limitations but can still provide you with valuable insight. Becoming more understanding of performance measures such as ROI will only continue to assist you in becoming more understanding of your investment portfolio.
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