Return on Investment (ROI) Formula
The ROI formula calculates the percentage return on an investment relative to its cost.
Essential for comparing investments.
The Formula
Return on Investment measures the gain or loss on an investment relative to its cost, expressed as a percentage. A positive ROI means profit. A negative ROI means loss.
Alternate Form
Variables
| Symbol | Meaning |
|---|---|
| ROI | Return on investment (expressed as a percentage) |
| Final Value | The total value received from the investment (sale price + any income received) |
| Initial Cost | The total amount originally invested |
| Net Profit | Final Value minus Initial Cost (equals gain or loss) |
Annualized ROI
To compare investments held for different periods, use annualized ROI:
Where n is the number of years the investment was held. This allows fair comparison between a 2-year and a 5-year investment.
Example 1
You invest $10,000 in stocks and sell them for $13,500 after two years. What is the ROI?
ROI = (13,500 − 10,000) / 10,000 × 100%
ROI = 3,500 / 10,000 × 100%
ROI = 35%
Example 2
What is the annualized ROI for that same investment (35% over 2 years)?
Annualized ROI = [(1 + 0.35)^(1/2) − 1] × 100%
= [1.35^0.5 − 1] × 100% = [1.1619 − 1] × 100%
Annualized ROI = 16.2% per year
Example 3
A business spends $5,000 on marketing and generates $2,000 in additional profit. What is the marketing ROI?
ROI = (2,000 − 5,000) / 5,000 × 100%
ROI = −60% (the marketing campaign lost money)
Limitations of ROI
- ROI does not account for the time period. A 20% return in 1 year is very different from 20% over 10 years.
- It does not account for risk. Higher-risk investments should deliver higher ROI to compensate.
- It can be manipulated by how costs and gains are defined.
- For time-sensitive comparisons, always use annualized ROI.
When to Use It
ROI is one of the most widely used metrics in business and investing.
- Comparing the profitability of different investment options
- Evaluating the effectiveness of marketing campaigns
- Justifying business expenditures to stakeholders
- Real estate investment analysis (buy/hold/sell decisions)
- Personal finance — evaluating whether an expense is worthwhile