What is Return on Investment? A guide to ROI and calculator.
What is Return on Investment? A guide to ROI and calculator.
What is Return on Investment (ROI)?
Return on Investment, commonly referred to as ROI, is a financial calculation used by investors to evaluate the efficiency of an investment or to compare multiple investments. ROI measures the profit generated by an investment relative to its initial cost, helping investors understand how effectively their money is working for them. Whether you are investing in shares, property, or businesses, knowing what ROI is and how to calculate it will help you make better-informed decisions.
Is ROI expressed as a percentage?
Yes, ROI is typically expressed as a percentage. This expression helps you quickly compare the profitability of different investments, regardless of the amount of capital involved, providing a clear picture of which investments are potentially more lucrative and putting investments into context against the prevailing rate of inflation and the level of risk involved.
For individual investors, ROI is a straightforward indicator of how much profit an investment has generated compared to the initial amount invested. It is expressed as a percentage, making it easier to compare the profitability of different investments regardless of their scale.
How is Return on Investment (ROI) calculated?
Return on Investment (ROI) is calculated using a basic formula.
What is the Return on Investment (ROI) formula?
The formula to calculate ROI is simple:
ROI = (Net Profit / Cost of Investment) × 100
To calculate ROI, follow these steps:
Identify the total return: This is the amount you receive from the investment, including dividends, interest, and any increase in value.
Deduct the total cost of the investment: This includes the initial sum invested plus any associated fees or costs.
Calculate the net profit: Net profit is the total returns from the investment minus the total cost of the investment
Apply the ROI formula: Using the values from above to determine the ROI as a percentage.
Example 1: Buy and sell shares.
If you buy shares for £1,000 and sell them later for £1,200, your net profit is £200. The ROI calculation on this investment would be as follows:
(£200 / £1,000) x 100 gives an ROI of 20%.
Example 2: Buy and sell shares with dividends and charges.
If you buy shares for £1,000, you receive dividends of £100, pay fees and charges of £50 and sell them later for £1,500, your net profit is £550. The ROI calculation on this investment would be as follows:
(£550 / £1,000) x 100 gives an ROI of 55%.
Return on Investment (ROI) calculator.
How to use the ROI calculator.
This ROI Calculator is designed to help you determine the return on investment for investments or savings products. Just follow the steps below to calculate your ROI:
Enter the purchase price: Input the total amount you originally paid for your investment, shares or the amount you paid into a savings account. Include the full cost without subtracting any dividends or fees yet.
Enter the sell price: Input the total amount you received when you sold the shares or the final value of your investment.
Enter dividends or income: If you received any dividends or income from your investment, please input the total amount here.
Enter fees, charges and costs: Input any costs related to the investment, such as platform fees, transaction costs or other charges.
Once you have filled in all the fields:
Click 'Calculate Return on Investment (ROI)': Press the button to calculate your net profit and ROI percentage.
ROI Calculator for Investments.
What Return on Investment is considered good?
The definition of a "good" ROI varies depending on the type of investment, the exposure to risk, the current market conditions, the inflation rate, the tax treatment of the profits and the timescale of the Investment.
For example, you will likely have different target ROIs on your stock market investments, 1-year fixed-rate cash-ISA savings, and long-term buy-to-let investments. The rationale behind this is that it all comes down to risk vs. return.
In basic terms, if you invested £10,000 in a 1-year 5% fixed-rate cash ISA, you will have £10,500 at the end of the year. This means your net profit will be £500, and your Return on Investment will be 5%. From an investment perspective, this is a guaranteed, low-risk investment that would grow faster than a 4% inflation rate.
However, you may consider that a 1% net gain against inflation isn't sufficient for you to meet your investment goals. As such, you may prefer to buy some funds in your stocks and shares ISA. Looking at the historical data, you think that in a fair market, your choice of funds could deliver a 12% return over the next 12 months.
As such, if you invested the same £10,000 into your chosen funds and they performed at the expected 12%, your money would have grown to £11,200 by the end of the same year. In this case, your net profit would be £1,200, and your ROI would be 12%.
With the same 4% rate of inflation in mind, this investment potentially delivers a much more satisfying return than the fixed-rate Investment in the cash ISA. However, the risk is greatly increased when you choose the stock market route, as the value of your investments can rise as well as fall, and you may expose yourself to sufficient risks to lose everything.
You may end up with less than the 5% fixed-rate rate you could have had, and your money may grow slower than the inflation rate, even though you have exposed yourself to greater risk. On the flip side, your money may grow at a better rate than expected, and you could generate an ROI greater than 15% in the year. There are no certainties involved when investing in the stock market.
This is the ongoing analysis that investors constantly battle with, which is often why many choose to split their investments between lower-risk fixed-return products, long-term, more risky investments in the stock market, where time can even out the returns, and investments in physical assets such as gold or property.
The question all investors need to ask themselves is:
If I can achieve X% with a fixed-return investment and inflation is likely to be Y%, how much does the potential return need to be to warrant the additional risk of investing my money in something else?
Why is Return on Investment important?
For individual investors, understanding ROI is crucial for several reasons. It not only helps in evaluating how well an investment has performed but also assists in making future investment decisions. By calculating ROI, you can identify which investments are underperforming and adjust your strategy accordingly, aligning your financial actions with your long-term goals and refining your tolerance for risk and reward.
Conclusion.
Calculating and understanding Return on Investment is a helpful skill for all investors. By applying the ROI formula, you can enhance your financial literacy, make more informed decisions, and work towards achieving your financial objectives more confidently. Remember, the key to successful investing is not just selecting the right assets but also continuously monitoring their performance through metrics such as ROI.
What’s next?
If you need help or advice on your personal finances or if you want to consider investing to make your money work harder, you can get in touch with one of our advisors for independent financial advice. We offer a free initial consultation. Based in Royal Tunbridge Wells, we advise clients across the UK.
Don’t forget, this article offers general financial information and should not be taken as personal advice. Remember that investments and pensions can go up and down in value, so you could get back less than you put in. Tax rules can change and will depend on your individual circumstances.