How to calculate ROI? An article clarifying the core equation of investment return rate

What is Return on Investment (ROI)?

To understand how to calculate ROI, you first need to know what it is. Return on Investment (ROI) is essentially an indicator of your earning ability—using numbers to measure how much profit your invested funds can generate, expressed as a percentage. Whether for personal finance or business evaluation, ROI is a key metric to determine if an investment is worthwhile.

How to Calculate ROI? The Core Formula Is That Simple

ROI = (Profit - Cost) / Cost × 100%

Breaking it down: the numerator is your net profit, and the denominator is your actual invested principal.

Here’s a straightforward example: buy stocks for 1 million, sell for 1.3 million, then ROI is (130-100)/100 = 30%. The key is not to omit any costs—transaction fees, commissions, taxes—all must be included.

How to Calculate ROI in Practice? Look at These Three Scenarios

Stock Investment ROI Calculation

Suppose you buy 1,000 shares at $10 each, sell at $12.5 after a year, and receive $500 in dividends, with $125 in trading commissions.

• Total Revenue = 12.5×1000 + 500 = $13,000
• Total Cost = 10×1000 + 125 = $10,125
• Net Profit = 13,000 - 10,125 = $2,875
• ROI = 2,875 / 10,000 = 28.75%

Advertising Campaign ROI Calculation

Cost of goods sold: $100, selling price: $300, selling 10 units, with $500 in advertising expenses.

• Total Revenue = 300×10 = $3,000
• Total Cost = 100×10 + 500 = $1,500
• ROI = (3,000 - 1,500) / 1,500 = 100%

Note: E-commerce practitioners often refer to “ROI” as ROAS (Return on Ad Spend), calculated as revenue / ad spend, which differs from true ROI. In the above example, ROAS = 3,000 / 500 = 600%.

How to Calculate Annualized ROI? Book Returns and Real Returns Can Differ Greatly

If Project A earns 100% over 2 years, and Project B earns 200% over 4 years, B seems to earn more, but what about annualized?

Annualized ROI = [(Total ROI + 1)^(1 / Number of Years) - 1] × 100%

• A: [(1 + 1)^(1/2) - 1] × 100% = 41.4%
• B: [(2 + 1)^(1/4) - 1] × 100% = 31.6%

A’s annualized return is higher, so ignoring time factors can lead to wrong investment decisions.

ROI vs ROA vs ROE, Don’t Confuse Them Again

In corporate evaluation, these three metrics are often mixed up:

Example: A company with assets of $1 million (of which $500K is debt, $500K is equity), after investing in a project returning $200K:

• Project ROI = 100%
• Company ROA = 150K profit / 1 million assets = 15%
• Company ROE = 150K profit / 500K equity = 30%

(Note: The above numbers are for illustration; actual calculations depend on specifics.)

How to Maximize Your Investment ROI? The Formula Only Has Two Ways

The formula indicates only two paths to improve ROI: increase profits or reduce costs.

In practice:

• Choose high-yield stocks to reduce erosion of returns
• Reduce trading frequency to pay fewer commissions
• Select low-fee brokers to save on every transaction
• Most directly: pick assets with high ROI

Generally, ROI ranking is: Cryptocurrency & Forex > Stocks > Indexes & Funds > Bonds

But remember, high ROI often comes with high risk. When choosing, consider volatility and valuation levels. For example, if a certain crypto’s volatility is twice that of stocks, you might allocate a 3:7 ratio to balance gains and risks.

Be Wary of These Pitfalls When Calculating ROI

Time Ignored: A 25% annual ROI and a 5-year ROI look different; you must convert to annualized to compare accurately.

Risk Underestimated: High ROI investments tend to be volatile; focusing only on returns can overstate attractiveness.

Costs Overlooked: In real estate, ignoring taxes, insurance, maintenance can significantly overstate ROI.

Returns One-Sided: ROI measures only financial returns; social and environmental benefits are ignored. Some have developed SROI (Social Return on Investment) to address this.

In summary, while the formula for ROI is simple, practical application requires comprehensive consideration of time, costs, risks, and true returns to make rational investment decisions.