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How to Calculate Your Return on Investment
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You invested in property a few years ago, and now you want to know: Was that investment worth it? To find out, you need to calculate your return on investment (ROI). We walk you through how to use the ROI formula and also where you can go for easy calculations.
The return on investment formula
To calculate your ROI, divide the net profit from your investment by the investment's initial cost, then multiply the total by 100 to get a percentage:
ROI = (net profit / investment cost) x 100
To calculate your net profit, subtract your stock's current value from the initial investment price.
Let's say you bought $5,000 worth of stock in a company. In three years, you sell it for $7,000. First, find your net profit: $7,000 – $5,000, so $2,000. Then divide your net profit by the initial investment cost of $5,000, multiplying by 100 to calculate the investment ratio:
ROI = ($2,000 / $5,000) x 100
In this case, you've earned a 40% return on investment—not bad.
The higher the percentage, the better your return on investment. A negative percentage, though, means you actively lost money on this investment.
Annualized return on investment
The ROI formula doesn't account for the amount of time you have a stake in an investment, otherwise known as the holding period. That also means the ROI formula doesn't account for compound interest, or the interest you accrue each year that contributes to the next year's interest. (Another way to think of compound interest is the interest you earn on interest.)
If you want to know how much you're earning year over year, accounting for compound interest, use the annualized return on investment formula:
Annualized ROI = [(1 + ROI)1/n – 1] x 100
In this formula, n means the number of years you're holding the investment, or the holding period.
Let's go back to our example above, where you determined that your ROI after three years is 40%, or, numerically speaking, 0.4. If you're calculating the annualized ROI, your formula should look like this:
Annualized ROI = [(1 + 0.4)1/3 – 1] x 100
Following this formula, your annualized ROI is about 11.87%.
Additional ROI calculations
A company's cash flow fluctuates from year to year, and so does your stock's value—which means you likely aren't going to earn the exact same ROI every single year. If you want a more detailed understanding of your ROI, then calculating your ROI and annualized ROI aren't enough. Instead, you need to make a few more calculations:
- The compound annual growth rate (CAGR), or annualized total return, measures your investment's potential growth rate year over year, assuming an average rate of growth and a reinvestment of funds at the end of each term.
- The internal rate of return (IRR) is a much more complicated equation that accounts for more detailed cash inflows (and, alas, outflows) over the course of an investment.
Tools for calculating your ROI
You can calculate your ROI by hand, but why bother? Online ROI calculators can simplify the process—just input the numbers and the calculator will crunch them for you. Alternatively, run the numbers through spreadsheet software like Excel or Google Sheets. Some investing sites offer free Excel templates to make calculating ROI (and more complicated financial metrics like IRR) a little simpler.
The return on investment equation doesn't tell you how much you're guaranteed to make on a given investment—no equation can tell you that for certain, since the lack of certainty is a key part of the game. Still, it's a useful calculation to have under your belt whether you're investing in stock for the first time or trying to determine if your next investment property will be worth what you paid for it.
Want more financial metrics for evaluating an investment? Check out our piece on another key financial ratio: the future value formula.
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