Return on Investment (ROI) is the most widely used measure of investment profitability. Whether you're evaluating a stock, a business project, or a marketing campaign, ROI tells you how much you gained relative to what you spent.

The ROI Formula

ROI = (Gain from Investment - Cost of Investment) / Cost of Investment × 100

Or simplified:

ROI = (Final Value - Initial Value) / Initial Value × 100

The result is expressed as a percentage.

Basic ROI Examples

Example 1: Stock Investment

You buy stock for $10,000. A year later, you sell for $12,500.

ROI = ($12,500 - $10,000) / $10,000 × 100 = 25%

Example 2: Business Project

You spend $50,000 on a new product line. It generates $75,000 in profit.

ROI = ($75,000 - $50,000) / $50,000 × 100 = 50%

Example 3: Marketing Campaign

You invest $5,000 in advertising. It brings in $8,000 in revenue with $3,000 in associated costs.

Net gain = $8,000 - $3,000 = $5,000

ROI = ($5,000 - $5,000) / $5,000 × 100 = 0%

Wait—you spent $5,000 and got $5,000 net. That's break-even, or 0% ROI. ROI measures profit, not revenue.

What's a Good ROI?

It depends entirely on context:

Investment Benchmarks

Business Benchmarks

A 10% ROI is great for stocks but terrible for a marketing campaign. Always compare ROI to appropriate benchmarks.

ROI vs Other Metrics

ROI vs CAGR

• ROI: Total return over any period
• CAGR: Annualized return rate

A 50% ROI over 5 years sounds good. But CAGR = (1.50)^(1/5) - 1 = 8.4% annually—decent but not spectacular.

Always note the time period. A 100% ROI over 10 years (7.2% annual) is very different from 100% ROI over 1 year.

ROI vs IRR

• ROI: Simple calculation, ignores timing
• IRR: Accounts for when cash flows occur

For investments with multiple cash flows over time, IRR is more accurate. ROI works best for simple "invest now, sell later" scenarios.

ROI vs Payback Period

• ROI: How much you earned (%)
• Payback Period: How long until you recoup your investment

Both matter. A 200% ROI over 20 years has a different risk profile than 50% ROI over 2 years.

Calculating Real-World ROI

Account for All Costs

Stock Investment True ROI:

Fees reduced ROI from 25% to 23.9%.

Account for Taxes

Pre-tax ROI: 25%

Tax on gains (20%): $500

After-tax ROI: ($2,000 / $10,000) × 100 = 20%

Account for Inflation

Nominal ROI: 25%

Inflation (3%): Reduces purchasing power

Real ROI: (1.25 / 1.03) - 1 = 21.4%

True returns are after fees, taxes, and inflation.

ROI Limitations

1. Ignores Time

100% ROI over 1 year = great

100% ROI over 10 years = mediocre

Always specify the time period or annualize for comparison.

2. Ignores Risk

A 15% ROI from a savings account (hypothetically) is better than 15% ROI from a speculative stock, because risk differs dramatically.

3. Ignores Opportunity Cost

A 10% ROI is poor if you could have earned 15% elsewhere with similar risk.

4. Can Be Manipulated

By choosing which costs to include or exclude, ROI can be made to look better or worse. Be consistent in calculations.

5. Doesn't Account for Cash Flow Timing

Receiving $10,000 today is worth more than $10,000 in 5 years. Simple ROI treats them the same.

Annualizing ROI

To compare investments over different time periods, annualize:

Annualized ROI = (1 + ROI)^(1/years) - 1

Example:

Investment A: 50% ROI over 3 years

Investment B: 80% ROI over 5 years

Annualized A: (1.50)^(1/3) - 1 = 14.5% per year

Annualized B: (1.80)^(1/5) - 1 = 12.5% per year

Investment A is actually performing better annually.

Using ROI for Decision Making

Comparing Investment Options

You have $50,000 to invest. Options:

Raw ROI suggests the business. But factor in risk (business could fail), liquidity (property is hard to sell), and effort (business requires active work).

Setting ROI Thresholds

For business projects, set minimum ROI requirements:

• Low risk: 10-15% minimum
• Medium risk: 15-25% minimum
• High risk: 25%+ minimum

Projects that don't meet the threshold for their risk level shouldn't be funded.

Tracking ROI Over Time

Monitor investments quarterly or annually:

• Is ROI meeting expectations?
• How does it compare to alternatives?
• Should you exit or double down?

Key Takeaways

• ROI = (Gain - Cost) / Cost × 100
• Always specify the time period—50% over 1 year differs from 50% over 10 years
• Account for fees, taxes, and inflation for true ROI
• Compare ROI against appropriate benchmarks
• Higher risk should demand higher ROI
• Annualize to compare investments over different time periods
• ROI is a starting point, not the whole picture—consider risk, liquidity, and effort

ROI answers the fundamental question: "Was this investment worth it?" It's not perfect, but it's the essential first step in evaluating any use of capital.