Calculating Investment Return: A Comprehensive Guide

Return On Investment, commonly called ROI, refers to the amount made or lost on an investment and is usually displayed in percentiles. There is no "normal" return on an investment because every investment has different risk characteristics that affect the desired return. So when speaking of returns on investment, professionals will not use the term "normal."

The Calculation

The mathematical calculation for determining ROI is fairly simple. You take the initial cost of the investment and subtract this from the investment's current value. You then divide this number by the original cost of the investment. Multiply this number by 100 and you will have the ROI in percentage terms.

Example Using Sample Numbers

For a hypothetical, let's say that you invested $100 originally and this investment is now worth $150 dollars. The ROI is calculated as: 150-100/100)*100, which equals 50 percent.

Warning

The ROI is a great tool for measuring investment returns after they have materialized. It is not as good for evaluating future investment decisions on its own, because it does not adequately deal with the risk or probability of an investment working out. Other analysis tools should be used in accordance with ROI including Net Present Value, or NPV, and Internal Rate of Return, known as IRR.

Internal Rate of Return

In the investment world, the IRR is more commonly used when evaluating different investment opportunities. The IRR is the discount rate that results in a net present value of zero and is the expected rate of return on that investment. Just like the ROI, the higher the IRR, the more desirable the investment. The main difference between ROI and IRR is that the IRR considers the timing of the investment. This makes it a more difficult metric to calculate and is a better indicator for making investment decisions.

Net Present Value

NPV refers to the present expected value of an investment. It is calculated by discounting the expected value of an investment to its worth in current dollars. In other words, NPV is the amount of money that a future sum of money is worth based the risk characteristics of obtaining that future sum of money. NPV measures the current value of future cash flows, whereas ROI measures the static return on a given investment.