Market Terms

What Is ROI?

ROI measures the gain or loss on an investment relative to its cost. Learn the ROI formula, how to calculate it, and what counts as a good ROI.

Definition

ROI (Return on Investment) is a financial metric that measures how much money you made or lost relative to how much you invested. The basic formula is: ROI = (Current Value - Cost) / Cost x 100. If you invested $10,000 and it's now worth $13,000, your ROI is 30%.

ROI can be applied to virtually any investment: stocks, real estate, a college education, a business venture, or even a marketing campaign. It provides a universal way to compare the efficiency of different investments. However, basic ROI does not account for the time period -- a 30% return in one year is very different from a 30% return over ten years.

For time-adjusted comparisons, investors use annualized ROI (also called CAGR -- Compound Annual Growth Rate). This tells you the equivalent annual return. A 30% total return over 10 years is roughly a 2.7% annualized return. The S&P 500's long-term annualized return (including dividends) is roughly 10% before inflation and 7% after inflation.

Real-World Example

You buy 100 shares of a stock at $50 per share ($5,000 total). Two years later, you sell at $65 per share ($6,500 total) and received $200 in dividends along the way. Your total return is ($6,500 + $200 - $5,000) / $5,000 = 34%. Your annualized ROI is about 15.8% per year. You can now compare that to alternative investments: a savings account earning 4% or the S&P 500 averaging 10%.

Why It Matters

ROI is the universal language of investing. Every financial decision involves an opportunity cost -- the return you could have earned elsewhere. By calculating ROI, you can determine whether an investment is worth your capital. A rental property earning 5% ROI when the stock market averages 10% should prompt questions about whether real estate is the best use of your money (though there are other factors like leverage, tax benefits, and diversification).

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Frequently Asked Questions

What is a good ROI?

It depends on the investment and time period. The S&P 500 averages about 10% per year over long periods. A savings account yields 4-5%. Real estate averages 8-12% including appreciation and rental income. Any ROI that beats your next-best alternative after adjusting for risk is 'good.'

What is the difference between ROI and CAGR?

ROI measures total return regardless of time. CAGR (Compound Annual Growth Rate) converts total return into an equivalent annual rate. A 100% total return over 7 years equals a CAGR of about 10.4% per year.

Can ROI be negative?

Yes. If your investment lost money, the ROI is negative. A $10,000 investment that is now worth $8,000 has an ROI of -20%.

Related Terms

Compound Interest

Investing Basics

Compound interest is interest earned on both your original principal and previously accumulated interest. Learn how it works, the formula, and real-world examples.

Capital Gains

Retirement Accounts

Capital gains are profits from selling an investment for more than you paid. Learn short-term vs long-term capital gains tax rates and strategies to minimize taxes.

P/E Ratio (Price-to-Earnings Ratio)

Market Terms

The P/E ratio measures a stock's price relative to its earnings per share. Learn how to calculate P/E, what's a good P/E ratio, and how investors use it.

APR vs APY

Personal Finance

APR is the annual interest rate without compounding. APY includes compound interest. Learn the difference and why it matters for loans and savings accounts.

Expense Ratio

Investing Basics

An expense ratio is the annual fee a fund charges as a percentage of your investment. Learn how expense ratios work, what's a good expense ratio, and why fees matter.

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