Return on investments is a ratio that helps you measure the profitability of your investments against the various investment costs. It is typically measured as net income by the original capital cost of the investment. Calculating ROI on an investment like stocks or mutual funds offers you insights into the potential returns on the same. ROI is typically presented as a percentage and calculated using the following ROI formula:
| Return on Investment = Net Profit/Cost of the Investment X 100 |
How to Calculate Absolute ROI
Absolute ROI is a way to understand how your investments perform over the short-term period, typically a year. You can calculate absolute ROI by using the following formula:
| Absolute ROI = Net Profit/Initial Investment X 100 |
Here, the Net Profit represents the final value of your investment minus the initial value of your investments. Let’s take an example to understand absolute ROI calculations. Suppose you invest Rs. 10,000 into the stock market and earn Rs. 13,000 after 1 year. Inputting these values into the above ROI formula, we get:
ROI = (13,000 – 10,000)/10,000 X 100
ROI = 30%
Or,
How to Calculate Annualised ROI
Calculating annualised ROI helps you understand the performance of your investment over different time periods. The annualised ROI formula is mentioned below:
| Annualised ROI = [Total Return/Initial Investment) ^ (1/Holding Period)] – 1 |
Let’s assume you have invested Rs. 10,000 and earned returns of Rs. 25,000 at the end of five years. To compute the annual rate of return, we input these values in the above annualised ROI formula we get:
Annualised ROI = [(25,000/10,000)^(⅕)] – 1
Annualised ROI = 0.2011 or 20.11%
What is an ROI Calculator?
Instead of manually completing ROI calculations, it’s always better to use an automated tool. The ROI calculator has uses the following information to calculate the profitability of your investments vis-a-vis their investment costs:
- Amount invested
- Amount returned
- Number of investment years.
Based on this data, this simulation tool calculates the return on investment, annualised return on investment, and the compounded annual growth rate (CAGR). You can use return on investment calculators available online to understand how ROI varies for a particular investment across different time periods.
Why is ROI Important in Investment?
Calculating return on investment is a critical part of financial planning due to the following reasons:
- Determine Profitability: Computing ROI helps you gauge how much profit you can make on an investment. This allows you to ascertain if the investment aligns with your financial goals like meeting certain income targets.
- Quantify Returns: ROI calculations are also used as a standardised metric to compare returns from different investments to make informed investment decisions. Based on these comparisons, you can prioritise opportunities with the best potential returns.
- Address Long-Term Goals: ROI calculations are particularly useful for long-term financial planning. They help you identify investments that offer a good CAGR and compounding potential to support your future financial goals.
- Monitor Portfolio Performance: Calculating ROI regularly can help you track the performance of your investments. You can make necessary adjustments to your portfolio based on these ROI figures and changing market conditions.
- Estimate Opportunity Cost: As an investor, you can better gauge opportunity cost by undertaking ROI calculations. Opportunity cost is defined as the cost of choosing one investment option over another and losing out on the potential gains from the other option. ROI calculations can come in handy especially when you have multiple investment options but limited resources. Return on investments can help you prioritise opportunities that offer better return forecasts.
What is a Good ROI?
Many investors often wonder, ‘what is a good ROI?’ The answer to this question is subjective since it is based on various factors like your end goals, risk appetite, and your investment horizon. As an investor, you need to ask yourself a few key questions like – How much risk can I afford to shoulder?, What is my time horizon for the investment?, How much profit do I want to make from this particular investment?, Are there any opportunity costs in selecting this investment?, What returns would I get if I invested elsewhere? Determining the answers to these questions will help you ascertain a good return on investment.
That said, there are certain general guidelines on a good ROI you can follow:
- Generally, a positive ROI in the range of 5%-7% is considered reasonable. Figures greater than 10% are considered strong ROIs.
- For stock investments, a 7% ROI post adjusting for inflation is considered good.
- ROIs greater than 5% are deemed good for gold investments.
For investments made in bonds, a good ROI stands around 4%-6%. - In the case of real estate investments, ROIs of 10% or higher are considered good.
- For alternative investments like cryptocurrency, ROIs can vary, but generally double digit ROIs are considered good.
Use Cases for ROI Calculation
Let’s understand ROI with a few real-world examples. Suppose you wish to invest in mutual funds to tap into compounding growth benefits and rupee-cost averaging. Now, there is an equity fund that offers an annualised ROI of 12.8%, but is also high-risk because equity funds are subject to market volatility. You also have the option of investing in a debt fund with an annual return rate of 8.2%. Since the fund invests in fixed-income debt instruments, it is relatively low-risk. Choosing between the two will depend entirely on your risk appetite as an investor and return expectations. You can use the annualised ROIs of the funds to compare the two options and assess how much risk you are actually willing to take on.
Similarly, you can use the concept of ROI in the context of real estate as well. If you have two properties and need to choose one, you can compare their ROI figures. Let’s say, Property A costs you Rs. 1 Crores, but also has the potential of appreciating to Rs. 2 Crores within the next year given its prime location. Property B costs you Rs. 70 Lakhs, but has the potential to appreciate to 1.6 Crores in the next year, but the catch is that the property is located in a relatively new and growing locality. Property A will give you a higher absolute profit of Rs. 1 Crore, with an ROI of 100%, while Property will give you a lower absolute profit of Rs. 90 Lakhs, but the ROI will be 128.57%. You can decide between the two based on these figures and other ancillary considerations.
