ROI (Return on Investment)
ROI measures the total return of an investment relative to its cost. It's the simplest way to evaluate investment performance.
Formula
Example
You buy stock for $1,000 and sell for $1,500. ROI = (($1,500 - $1,000) ÷ $1,000) × 100% = 50%.
How to Interpret It
ROI doesn't account for time. A 50% ROI in 1 year is excellent; in 10 years, less impressive. For time-adjusted returns, use CAGR.
Simple ROI vs. Annualized ROI
Simple ROI: ($300K - $200K) ÷ $200K = 50%
Annualized (10 years): (300÷200)^(1/10) - 1 = 4.14% per year
Annualized (2 years): (300÷200)^(1/2) - 1 = 22.47% per year
Same 50% total return, vastly different annual performance. Always annualize when comparing investments held for different periods.
Real-World Examples
- Stock purchase: Bought 100 shares at $20 ($2,000), sold at $26 ($2,600). ROI = ($2,600 - $2,000) ÷ $2,000 = 30%.
- Stock with dividends: Bought at $50, sold at $60, received $2 dividends. ROI = (($60 - $50) + $2) ÷ $50 = 24%.
- Real estate: Bought for $300K, sold for $360K after 3 years. Simple ROI = 20%. Annualized ROI = 6.27%.
Common Mistakes
- Ignoring time horizon: Comparing a 50% ROI over 1 year vs 10 years without annualizing is meaningless.
- Forgetting transaction costs: Trading fees, taxes, and commissions reduce actual returns. A $2,000 investment with $50 in fees starts at $2,050 cost basis.
- Not including dividends: For dividend stocks, excluding dividends understates true ROI significantly.
- ROI vs. IRR confusion: ROI is simpler but ignores cash flow timing. IRR (Internal Rate of Return) accounts for when money goes in and out — critical for investments with multiple contributions.
Pro Tips
Always annualize: When comparing any two investments, convert both to annualized returns. This makes stocks, bonds, real estate, and business investments directly comparable.
Include all costs: For stocks, include commissions + bid-ask spread + taxes. For real estate, include closing costs + maintenance + property tax. The "real" ROI is always lower than the headline number.
ROI vs Other Return Metrics
| Metric | Best For | Limitation |
|---|---|---|
| ROI | Quick comparison of any investment | Ignores time period |
| CAGR | Annualized growth over multiple years | Assumes steady growth |
| ROE | How efficiently equity generates profit | Affected by debt levels |
| ROA | How well assets produce returns | Varies by industry |
| IRR | Complex cash flows with timing | Harder to calculate |
Frequently Asked Questions
What is a good ROI for stocks?
The S&P 500 historically returns about 10% annually (before inflation). So a good ROI for stocks is anything above 10% per year. For real estate, 8-12% is typical. For a new business, investors often look for 15-30% ROI to compensate for higher risk.
What's the difference between ROI and profit?
Profit is the absolute dollar amount you earn. ROI is the percentage return relative to your investment. A $1,000 profit on a $5,000 investment is 20% ROI, but the same $1,000 on a $100,000 investment is only 1% ROI. ROI lets you compare investments of different sizes.
Does ROI account for the time held?
Basic ROI does not. A 50% ROI in one year is excellent, but 50% over ten years is mediocre. To compare across time periods, convert to an annualized return (CAGR) or use the CAGR formula.