In general terms, a “return on investment” can apply to the amount of time, effort, or stress an activity will cost you versus the reward it may yield. Staying up til 3 a.m. to binge-watch the latest season of your favorite show will provide you with a few hours of suspenseful entertainment — but is it worth the loss of sleep and the risk of ticking off your leering manager by falling asleep at work the next day?
In other words, does the return on investment justify its cost? When you invest in something, you expect to earn something from it — to profit or benefit. If the reward is not proportional to the effort, you wouldn’t reasonably do it.
The primary use of this term is in business finance and investments, and it is used to refer to potential gains or losses of money. Interested in becoming an investor? To do so, you must understand how to determine the return on investment (ROI) of each opportunity you encounter. Whether you’re interested in real estate investment or playing the stock market, this metric is key.
If you want to learn more about how you can use this approach to assess investment opportunities, read on. This guide will teach you how to calculate your ROI to make the best financial decisions for your needs.
What Is Return on Investment in Finance?
While ROI in the context of time, energy, and effort can be subjective, it is an objective metric in finance. ROI is a percentage that indicates the value of an investment by comparing its cost to the amount the investor earns. It is an important component in the art of value investing. The formula to calculate ROI can be found in the section below.
A positive figure indicates profit, while a negative figure indicates loss. Negative or low percentages indicate investments that are likely not worth your time, while high percentages may signal lucrative opportunities. This figure is key to comparing investment opportunities.
Many people establish their livelihoods making investments, and they do so by rigorously researching and weighing risks. Whether you are interested in making short-term investments or playing the long game, research to determine potential ROI of each opportunity is essential. Without measuring possible returns, investing is practically indistinguishable from gambling.
Remember that your personal financial situation should influence what you deem an acceptable cost or risk to be. Withdrawing part of your savings to invest in the stock market may be a reasonable expense to justify returns. Racking up charges on your credit card to do so is probably not. You can only make smart moves when you know what your boundaries are. With that in mind, let’s discuss how to calculate the ROI of investment opportunities.
How to Calculate ROI
By evaluating and comparing the ROI of different investment opportunities, you can maximize your investment potential. If you invest $100 and will earn $120 on average, that opportunity has an average ROI of 20%. As noted above, an ROI can be negative. If you invest $100 and will only receive $80 back, that opportunity has an ROI of -20%.
Calculating your ROI involves subtracting an investment’s cost from its return, then dividing that number by the cost. Let’s use the first example above to illustrate:
$120 (return from investment) – $100 (cost of investment)
$100 (cost of investment)
Taking $100 from $120 leaves you with $20. That number divided by $100 equals .2 — or 20%, your ROI.
You can use this figure to compare different investments. However, it’s important to evaluate total costs and total returns in order to perform a fair and accurate comparison. Failing to include costs or returns will result in an inaccurate ROI, which could lead to misinformed investments.
Ensure you’re getting the full picture in your assessment, which can include the length of the investment. Time plays a key role when comparing ROIs, particularly for long-term investments. Determining the return you can expect over the course of a year will give you the annualized ROI of that opportunity.
Let’s say two investment opportunities are available, and they both have an ROI of 20%. Investment A will get you that return in a period of three months, while investment B will do so in three years. The annualized ROI for A will be substantially greater than B, indicating that it is the superior investment.
Calculating the annualized ROI is a far more involved process than the formula used above, but the ROI calculator below can help you determine this percentage quickly.
While the simple example above is purely illustrative, calculating ROIs can get complicated. Doing this process repeatedly to compare investment opportunities can get tiring quickly. Thankfully, there is an ROI calculator online that can help you do so. Keep this handy when exploring your options to make wise investment decisions.
Strong intuition is vital for an investor, but good research is arguably more important. With this information, you’ll be better armed to make wise investments. Regardless of the field or niche you want to invest in, calculating your potential ROI will help you find lucrative opportunities and create a strong foundation for your investment portfolio.
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