How to Calculate Return on Investment

|

The return on investment (ROI) formula can help you understand how much you earn on an investment relative to its cost. 

You can use the ROI investment formula to calculate ROIs on various types of investments, including stocks and bonds, and it can be helpful when you’re comparing two investments. You can also use it when reviewing your portfolio to understand which investments are performing better than others. 

The return on investment formula is:

ROI = (Current Value - Cost)/Cost

For example, if you bought a stock at $100 and it’s now worth $110, your ROI is 0.1. Or, you can multiply the result by 100 to see your ROI as a percentage—10% in this case.

 

How to Calculate Rate of Return

You can also use the same formula to calculate the rate of return (ROR), which serves a similar purpose—understanding how much you earn (or lose) on an investment relative to its cost. 

The difference is that the ROI generally doesn’t have a time period associated with it, while most people think of a ROR over time. While the simple rate of return formula doesn’t include time as a variable, a ROR is often associated with a year.

Time periods can be important whether you’re considering new opportunities or revisiting long-term holdings. An investment with a 100% ROI (after five years) will earn you less money than an investment that maintains a 25% annual ROR over five years. 

How to Calculate Total Return

Building off the ROI/ROR formula, you may want to add additional forms of income or expenses to calculate your total return from an investment. Some stocks may pay out dividends, bonds could offer coupons, and you may have to pay brokerage fees for each trade.

The total return formula takes interest, dividends, capital gains, and expenses into account to help you understand your actual rate of return in a specific time period—again, generally over a year. 

For a stock, the total return formula is:

Total Return = [(Current Value - Cost) + Dividends - Expenses]/Cost

For example, if a stock increased from $100 to $110 over a year, paid out a $4 dividend, and it cost $10 per trade, the equation is:

Total Return = [(110 - 100) + 4 - 10]/100 = 0.04

Or, 4% if you multiply by 100 to get the percentage total return. 

Because the total return includes the income from an investment and the investment’s growth, it could be important you’re considering two investments that have different interest or dividend rates. Also, know that some people and companies may use this more inclusive equation when calculating ROI/ROR, even if they don’t specify it’s the total return. 

 

How to Calculate Annualized Return on Investment 

If you’re holding an investment for multiple years, you may want to calculate your annualized return on investment (AROI). The result is the average annual gains (or losses) from an investment, which you can then compare to a broad index to see if you “beat” the market.

The annualized ROI formula builds off the simple ROI equation: 

AROI = [(1 + ROI)1/n - 1

The n represents the number of years you’ve held the investment. If it’s been less than a year, or part of a year, you can use a decimal. For example, 1/1.5 if you’ve held an investment for a year and a half. 

Using the example investment from above, say you hold the stock for five years, its value increases to $175, and it paid out the 4% dividend five times. Here are the ROI and annualized ROI equations:

ROI = [(175 - 100) + (4 x 5) - 10]/100 = 0.85 or 85% 

AROI = [(1 + 0.85)1/5 - 1 = 0.13 or 13% 

As with the simple rate of return formula, you can use the AROI equation to compare your investments and see which ones are performing best. If you can approximate investment opportunities' ROI, you can also estimate their AROIs to determine which investments to buy. 

Putting the ROI Equations Into Action

The ROI and AROI formulas are relatively simple and only the tip of the iceberg when it comes to investment analysis. 

For example, you might be considering two investments that have very different risk profiles—such as a small cap stock and a treasury bond. Even if their ROIs over the last two years are identical, the ROI and AROI formulas don’t consider risk. Instead, you may want to calculate the risk-adjusted return to determine which will fit best in your portfolio. 

However, the simplicity of the ROI and AROI formulas makes them helpful for novice and expert investors alike. 

You can use the formulas to quickly calculate returns on a single position or a portion of your portfolio. Or, you could compare returns on the funds you manage with investments a financial planner oversees. They results can help you decide which positions to hold, sell, or buy when you’re rebalancing your portfolio. And you can swap out fees or expenses to see how changing investments or platforms could impact your returns.