Making a smart investment decision often comes down to one simple question: is it worth it? Answering that question with confidence requires a way to measure the potential return against the initial cost.
This is where understanding Return on Investment, or ROI, becomes essential. It’s a straightforward metric that helps you see the profitability of your choices, turning complex financial outcomes into a clear, comparable figure.
The ROI Formula
The standard formula to calculate ROI is: (Current Value of Investment – Cost of Investment) / Cost of Investment x 100. This calculation gives you a percentage that represents the gain or loss on your investment relative to how much you put in.
A positive percentage indicates a profit, while a negative one signifies a loss. It’s a direct way to assess an investment’s performance.
Figuring Out Your Investment Cost
To accurately calculate ROI, you need a complete picture of your total investment cost. This includes the initial purchase price plus any additional expenses incurred. Think about transaction fees, maintenance costs, taxes, or any other money you had to spend to acquire and maintain the asset.
A thorough accounting of all these costs is fundamental for a true ROI calculation.
Measure Your Earnings
Determining your earnings means looking at the current value of the investment. For some assets, like stocks, this value is the current market price. For others, it might be the revenue generated or the savings achieved from the investment.
Whatever the case, you need a clear and consistent method for measuring the financial gain to ensure your ROI figure is reliable. You can then use this to figure out what is a good rate of return on investments.
What Your ROI Results Mean
Interpreting your ROI is straightforward. A 25% ROI means you earned 25 cents for every dollar you invested. A -10% ROI indicates you lost 10 cents for every dollar. This percentage allows you to compare different investments on an equal footing, regardless of their size or type.
When you work with a financial partner like SoFi, understanding these numbers helps you and your advisor make more informed decisions about your portfolio.
The Limits of ROI
While ROI is a powerful tool, it does have its limitations. The primary one is that it doesn’t account for the time it takes to generate a return. An investment that returns 20% in one year is much better than one that takes five years to achieve the same result.
ROI also doesn’t consider risk; a high-potential ROI might come with significant uncertainty.
Beyond ROI
For a more complete financial picture, it’s wise to use ROI alongside other metrics. Consider looking at the payback period, which tells you how long it will take to recover your initial investment.
You could also evaluate the internal rate of return (IRR), which accounts for the time value of money. Combining these metrics gives you a more well-rounded view of an investment’s potential.
