Understanding Return on Investment (ROI)

Return on Investment (ROI) is a key financial metric used to evaluate the profitability of an investment. It’s widely employed across various asset types, including business ventures, real estate, and personal investments like brokerage accounts.

What is ROI?

ROI is a percentage that measures the profitability of an investment by comparing the net profit or loss to the initial investment cost. It helps investors gauge how effectively their money has been utilized.

How to Calculate ROI

Calculating ROI is essential for assessing investment performance. It’s expressed as a ratio or percentage and is determined using the following formula:

ROI = Current Value of Investment − Cost of Investment / Cost of Investment

In shorthand, it can also be expressed as:

ROI = Net Profit/Cost of Investment

For example, if you invest $10,000 in a stock and it grows to $12,000 after a year, the ROI would be:

ROI = 12,000−10,000 / 10,000=0.20 or 20%​

Why ROI Matters

ROI is valuable because it helps investors evaluate the success of their financial decisions. It provides a clear picture of investment efficiency and guides future strategies.

Limitations of ROI

While ROI is a useful metric, it has its limitations. It may oversimplify complex financial situations by not considering factors such as time, opportunity cost, and investment risks.

ROI and Risk

Higher potential returns often come with increased risks. It’s important to calculate ROI along with the risk level of an investment to make informed decisions.

The Bottom Line

ROI is a crucial metric for assessing investment profitability. While it offers valuable insights, it’s important to recognize its limitations and consider both ROI and risk in your investment decisions.

Investment advisory products and services made available through AE Wealth Management, LLC (AEWM), a Registered Investment Adviser. Investing involves risk, including the potential loss of principal. This is a hypothetical example provided for illustrative purposes only; it does not represent a real life scenario, and should not be construed as advice designed to meet the particular needs of an individual’s situation. 2538064-08/24