Investing & Markets

What is ROI?

Return on Investment (ROI) measures how profitable an investment is relative to what you paid for it. It is calculated by dividing the net profit of an investment by its original cost, expressed as a percentage. ROI provides a simple tool to compare the performance of different investments.

The formula for ROI is: (Current Value of Investment - Cost of Investment) ÷ Cost of Investment. A positive ROI indicates a profit, while a negative ROI represents a loss.

While ROI is a versatile metric, it has limitations. It does not account for the holding period of an investment. An investment that generates a 50% ROI over 10 years has a lower annual return than one that generates a 20% ROI in one year. Lenders and investors often calculate annualized ROI to address this limitation.

Quick Facts

Formula(Net Profit ÷ Original Cost of Investment) × 100

Primary BenefitSimple, standardized comparison of investment profitability

Primary LimitationDoes not incorporate the holding period or time value of money

Alternative MetricAnnualized ROI adjusts returns for time elapsed

PRACTICAL EXAMPLE

An investor buys shares of a mutual fund for $10,000 and sells them three years later for $13,000, earning a net profit of $3,000. The ROI is 30% ($3,000 ÷ $10,000), representing a 10% average annual return.

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Learn More Key Concepts

StockA financial security representing a fractional share of ownership in a corporation, conveying voting rights and claims on assets.

PortfolioA collection of financial investments, such as stocks, bonds, cash equivalents, and alternative assets, held by an investor.

YieldThe income return on an investment, expressed as an annual percentage based on the asset's cost or market value.

P/E RatioA valuation ratio calculated by dividing a company's current share price by its earnings per share.

Compound InterestInterest calculated on both the initial principal and the accumulated interest of prior periods, driving exponential growth.

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