The return on investment (ROI) measures the profitability of an investment. It is often expressed as a ratio or a percentage. ROI provides a way to evaluate and compare assets or financial instruments.
Definitions and Examples
Investors calculate ROI to determine profit or loss compared to the cost of their portfolio. ROI tells us how profitable investments are. It also allows for comparison of future investments for potential growth.
How to Calculate ROI?
The basic formula for calculating ROI is:
When it comes to determining the ROI of an investment, things get more complicated. This is because the ROI of an investment often involves trying to capture the value of money over time.
Depending on your needs, there are some formulas that can help you get an idea of whether your investments are yielding profit. Some are more complex than others, but no formula exceeds the average person’s ability to use a calculator.
1. What is Total Return?
Total return measures the profit that investments achieve over a specific period of time. This measure includes earnings from dividends, making it a good way to assess the profitability of certain stocks. Total return is often expressed as a percentage.
Definition of Total Return
Total return captures the combined value of investment profits over a specific time period, such as quarterly or annually. These returns may include interest, dividends, and changes in the value of the investment.
How to Calculate Total Return?
It’s simple math, but it reminds us that we must ensure to include dividends (where applicable) when finding stock returns. This is the formula:
For example, if you bought a stock for $7,543, and now it is worth $8,876, you have an unrealized gain of $1,333. If you received dividends of $350 during this period, you can calculate the total return using these steps:
(8876 – 7543) + 350 / 7543 = 1333 + 350 / 7543 = 1683 / 7543
In this case, the total return will be 0.2231 or 22.31%.
2. What is Simple Return?
Simple return is similar to total return, but it is used to calculate investment return after selling it.
Definition of Simple Return
Simple return calculates the total returns on your investment, taking into account the cost basis.
How to Calculate Simple Return?
You can find your simple return using this formula:
Suppose you bought a stock for $3,000 and paid a commission of $12. Your cost basis will be $3,012. If you sold the stock for $4,000 (with another commission of $12), your net proceeds would be $3,988. If your dividends were $126, you can calculate the simple return using these steps:
3988 + 126 ÷ 3012 – 1 = 4114 ÷ 3012 – 1 = 1.36 – 1
In this case, the simple return will be 0.36 or 36%. Like the total return calculation, simple return does not tell you how long the investment lasted.
3. What is Compound Annual Growth Rate?
For investments you hold for more than one year, you may want to consider this advanced calculation, but it is not much more complex.
Definition of Compound Annual Growth Rate
The Compound Annual Growth Rate (CAGR) shows the value of money in your investment over time. A 40% return over two years is great, but a 40% return over ten years leaves a lot to be desired. Consider this calculation as the growth rate that takes you from the initial investment value to the final investment value. It assumes that the investment has compounded over the period.
How to Calculate Compound Annual Growth Rate?
To calculate CAGR, use this formula:
Divide the ending value of the investment by its value at the beginning of that periodTake that result and raise it to the power of oneDivide it by the length of the period (n)Subtract one from that result
It is a…
CAGR is useful when comparing investments over time, but it standardizes returns over the comparison period. This may reduce the focus on risks in volatile investments.
Source: https://www.thebalancemoney.com/determine-return-on-investment-3140687
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