Detailed Explanation
Return on Investment (ROI) measures investment efficiency by comparing gains to costs. It’s the most widely used metric for evaluating and comparing investment performance.
ROI Formula
Basic ROI: (Current Value - Original Cost) / Original Cost × 100%
Example: Bought for $10,000, now worth $15,000 ROI = ($15,000 - $10,000) / $10,000 = 50%
Important Considerations
Time Matters: A 50% return over 5 years is very different from 50% over 1 year. Use annualized returns for fair comparison.
Include Everything:
- Capital appreciation
- Dividends and distributions
- Interest payments
- Minus: fees, taxes, expenses
Real vs. Nominal: Real ROI adjusts for inflation. A 7% return with 3% inflation = 4% real return.
Historical Investment Returns
| Asset Class | Avg Annual Return (historical) |
|---|---|
| US Stocks (S&P 500) | 10-11% |
| International Stocks | 8-9% |
| Bonds | 4-6% |
| Real Estate | 8-12% |
| Cash/Savings | 2-5% |
| Inflation | 2-3% |
Examples
Stock Investment ROI
| Metric | Value |
|---|---|
| Purchase price | $10,000 |
| Dividends received | $800 |
| Current value | $14,000 |
| Total return | $14,800 - $10,000 = $4,800 |
| ROI | 48% |
Rental Property Cash-on-Cash ROI
| Metric | Annual |
|---|---|
| Down payment | $50,000 |
| Rental income | $24,000 |
| Expenses | $18,000 |
| Net cash flow | $6,000 |
| Cash-on-Cash ROI | 12% |
401(k) with Employer Match
| Metric | Value |
|---|---|
| Your contribution | $10,000 |
| Employer 50% match | $5,000 |
| Total invested | $15,000 |
| Instant ROI | 50% (from match alone) |
Why It Matters
ROI is a useful metric for evaluating financial decisions:
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Compare Options: Standardized metric for comparing completely different investments.
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Measure Success: Are your investments meeting expectations or underperforming?
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Prioritize Resources: Direct money toward higher-ROI opportunities.
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Evaluate Decisions: Any financial choice can be framed as ROI (education, career change, home improvement).
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Benchmark Progress: Compare your returns against market indices and goals.
Tracking investment ROI over time-ideally in a spreadsheet-shows which holdings perform well and which drag down your portfolio.