Return on Investment
Successful investors always take every precautionary measure to put their money in the most profitable instruments. There are multiple ways you can compare different investment options to determine which offers the highest returns.
One popular method is the Return on Investment (ROI). You can use an ROI calculator to compare different investment products quickly.
What is Return on Investment (ROI)?
ROI shows the ratio between total profits made from an investment and the total investment cost. Simply put, you can use the ROI method to compare the invested amount and the income earned. It also helps understand the profitability of an investment option and decide if it is a good choice for you.
Another important aspect of ROI is that you get the answer in percentage form. So, if the calculation shows the result is 0.20, it means the ROI is 20%.
ROI is a commonly used method to calculate investment profitability because it is quick and simple. Moreover, the data required for ROI is easy to determine; you know how much money you will invest, and most investment products show the potential returns.
Additionally, ROI shows the result in percentage form, which is easy to understand. It makes comparing different investment options a simple task, allowing you to choose the best financial instrument.
One essential thing to know about ROI is that it refers to different types of measurements, which include Average Rate of Return (ARR), Earnings per Share (EPS), and the Return on Invested Capital (ROIC). But investors use it more frequently to measure the simple return on investment.
You can estimate ROI in seconds by using an ROI calculator online.
About ROI calculator
The calculator allows you to compute ROI effortlessly. It has sections where you need to provide the investment amount and expected returns. You must also mention the investment period for the tool to work. Once you input the details, the calculator will show you the Gain on Investment, Return on Investment, Absolute ROI, and Compound Annual Growth Rate (CAGR).
The formula to measure ROI
The calculator makes it simple for you to determine the ROI, but it is always wise to learn how the ROI formula works. It plays a crucial role in investments and can make all the difference between choosing the right investment product and suffering loss.
To use the formula, you need Gain from Investment (G) and Cost of Investment (C).
Based on the above information, the formula is ROI = [(G – C) / C]. You can multiply the result by 100 to determine ROI percentage.
One disadvantage of the formula is that it only considers the numerical values provided but cannot calculate the associated risk with any investment instrument.
How does the ROI calculator work?
Now that you know how to calculate ROI using the formula, it is time to understand how the calculator works with the equation. When you input investment amount, expected returns, and investment period, the calculator uses the above formula to determine Absolute Return. It then shows the value in percentage form.
As you can see, calculating the Absolute Return does not require using the investment period. But the calculator needs the information to determine Annualized Return on Investment, which is the investment product’s performance over different periods.
The formula for Annualized ROI is more extensive compared to Absolute Return.
Let us understand both aspects of using ROI with different examples.
Example of ROI calculation
Suppose you bought a property worth ₹60 lakhs, and you sell it for ₹90 lakhs after 5 years.
By using the formula, [(G – C) / C], we get the Absolute Return: (₹90 lakhs – ₹60 lakhs) / ₹60 lakhs = 0.50.
So, the return on the investment in your property is 50%.
Annualized Return on Investment (ROI) formula and example
The basic ROI calculation formula does not include the period during which you held the investment, which is the holding period. If you want to take the holding period into account, Annualized ROI can help. The formula for Annualized ROI: [(1+ROI)1/n − 1] x 100%
In the formula, ‘n’ is the holding period in terms of the number of years.
Let us apply the same example as above to understand how the calculation for Annualized ROI works.
- Investment: ₹60 lakhs
- Total return: ₹90 lakhs
- ROI: 0.50
- Holding period: 5 years
So, the Annualized ROI is [(1 + 0.50)1/5 − 1] x 100% = 8.45%.
If the holding period is less than a year, you can still use the formula by converting ‘n’ into a fraction of a year. Check the below Annualized ROI calculation example:
- ROI: 0.10
- Holding period: 6 months = 0.5 years
- So, the Annualized ROI will be: [(1 + 0.10)1/0.5 − 1] x 100% = 21%
Benefits of ROI
ROI calculation offers many benefits. Below is a list of the six most significant ones.
1. Easy profitability measurement
ROI provides you with a clear idea about the profitability of an investment option. This allows you to compare different products to determine which one can generate the most profit quickly. So, you can use your available assets better and get the best out of your investment. You may also compare the cost with the profit of each investment product to determine their rate of return.
2. Increasing overall profit
If you maintain a diversified investment portfolio, you can measure the overall ROI of the portfolio and the ROI of every individual investment plan. This makes it easy to measure the profitability of every financial product under the portfolio and determine where you can make improvements. When the ROI of one instrument improves, the overall ROI increases.
3. Quick comparative analysis
If you want to invest in stocks, it is important to compare different companies in their asset utilization and productivity before deciding where to put your hard-earned money. ROI becomes even more essential when comparing businesses of similar size, belonging to the same industry.
You may use the ROI calculation to analyze the different companies’ profitability closely, allowing you to make an informed choice.
4. Performance measurement
A key factor of maintaining a profitable investment portfolio is keeping a close eye on every asset. ROI helps you determine which options are performing well and which are not. Based on that, you can buy and sell products from your portfolio to ensure maximum profits.
If you want to invest your money in a fund, ROI will also help compare the performance of different funds. You may then choose the one that has been performing well over the years.
5. Choosing an investment company
If you are considering using the services of an investment company, there are multiple things you have to first check. The company must be excellent at asset utilization, cost management, pricing strategy, and marketing apart from investment planning.
A company with a high ROI percentage shows the signs of being good at what they do.
6. Simplicity of use
The data required to calculate ROI is readily available. You only need to know the investment cost and probable returns to calculate ROI. So, it is a simple procedure that almost anyone can use to make the right investment decisions.
Drawbacks of ROI
ROI has a few limitations, too. Three of its drawbacks are as follows:
1. Definition of profit differs
The word ‘profit’ may have different definitions. The amount of profit from an investment product depends on multiple factors such as taxes and interests. Some instruments might even have associated costs that are deducted from the return, lowering your profits. As ROI does not take all these into account, the result might not always be accurate.
2. Difficult to compare different companies
Development expenditure, fixed asset valuations, stock price assessment, and many other financial aspects vary between companies. So, a simple comparison of different companies based on ROI might not always offer a clear picture.
3. Does not account for risk
ROI only accounts for Gain from Investment and Cost of Investment. It ignores multiple other factors associated with an investment, such as risk. An investment product with a high rate of return can be risky as well. As ROI does not consider that, the result might not always be precise.
1. Why does the ROI calculator show both Absolute Return and Annualized ROI?
Absolute Return only shows your profit percentage from any investment held for one year or less. To compare returns during an extended holding period, you need to use the Annualized ROI calculation.
2. How can the ROI calculator help?
The calculator makes it easy to compare different investment products. It gives you an idea about which investment avenue has a better chance of providing higher returns.
3. Is it difficult to use the ROI calculator?
No, the calculator is quite easy to use. You only need to input the investment amount, expected returns, and investment period on the tool. It will do the rest and show you the result within seconds.
Many investors use the ROI calculator in India. It can be a great tool if you know how to use it properly. Remember the points provided in this article when using it to get quick results and make the most of your investments.
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