You will also get to know about simplified ways to Calculate ROI, which will help compare the investments. This is because all the ROI calculations are not created equal, but some offer you numerous insights and provide accurate comparisons across various investment assets.
If you are confused between different investment options and you are not getting an idea of which will help you in providing more profit, then get to know the complete details regarding the return on investment.
What is Return On Investment?
ROI stands for return on investment. It is a tool for measuring the profitability of any investment. Investors can use this technique in order to get an idea about the profit of their investment. It is a simple percentage formula that helps you in getting details about how much you have earned as compared to how much you have put while investing.
Basic ROI Formula
ROI = [(Final Value – Initial Investment) / Initial Investment] × 100
This formula helps you in getting an idea about the profit you have earned on your investment. It includes subtracting the initial investment from the final value you have received along with profit. It will be divided by the initial investment, and you will get a percentage of return on your investment. This will be helpful for you to get a complete idea about the performance of your investment and what you are getting in return.
Different Ways to Calculate ROI
There are numerous ways to calculate return on investment. These different ways are helpful in providing you complete idea about comparing the investment.
Simple ROI
A simple ROI helps in providing fast analysis of the profit on your investment. It is a quick method and is considered mainly by beginner or intermediate investors. Numerous new investors don’t have any idea about the complex ROI formulas, so they choose simple ROI to get an idea of the profit they have received from the money they have invested. If you want to do a single-period analysis, then it will be helpful.
But along with this, there are some limitations of this formula as well. It does not consider time and ignores the effect of compounding. Moreover, this formula can be misleading when you are comparing long-term and short-term investments.
ROI = (Net Profit / Cost of Investment) × 100
Annualized ROI
This method of calculating ROI is considered the golden method. This method is used as a standard for comparing ROI from various investments. You can consider this method because of its efficiency in the comparison of different investment types. Furthermore, it standardizes the returns on your investment in a yearly format. Also, it is ideal for comparing bonds and mutual funds.
Annualized ROI = [(Ending Value / Beginning Value) ^ (1 / Years)] – 1
Time Weighted Return
TWR helps eliminate the impact of cash movements. It makes it perfect for tracking any investment. The most common advantage of using this method is that it neutralizes the timing effect of your contributions. But it also has a challenge, which includes the complexity of calculating the profit manually. Also, this method is less useful for personal analysis or single investment analysis.
Internal Rate of Return
The internal rate of return is also a method used for calculating ROI when comparing different investments. It is mainly used for complex cash flows. It is the rate at which an investment breaks. This method is used when the cash flow varies according to the time.
Also, this method is used when you are specifically comparing real estate projects or other business investments. But you should remain cautious because it can be tricky for computation as well as it can provide multiple values.
Which ROI Method is Most Effective for Comparison?
If you are searching for the most effective and simple method of comparing ROI, then annualized ROI wins the game. It is highly preferred because it is accurate and easy to interpret. Moreover, this method works for various asset types. In addition to this, this method is also considered for long-term investment planning. So, it provides you with a complete and clear result of ROI after comparing various investment types.
FAQs
1. Can ROI be negative?
Ans. Yes, ROI can be negative as well. If your investment loses money, then ROI will drop, which will be harmful.
2. Should I only prefer one ROI method?
Ans. No, it is not completely necessary. For quick checking, you can use simple ROI, but for comparison, you must use annualized ROI. Also, if you want to have advanced analysis, then IRR and TWR should be adopted.
3. Is IRR better than annualized ROI?
Ans. IRR is mainly considered for complex conditions when there is an uneven flow of cash. But for a simple comparison, annualized ROI is used, which is clear and simple.
Wrapping Up
You are provided with a variety of ROI methods. These methods depend on the needs of the investor. If you want to do a financial comparison of different investments, then annualized ROI is the preferred choice. This will help you in determining which investment type is better for you and which will result having a loss. So, get to know the complete details using these ROI methods.