What is Return on Investment?

ROI is expressed as a percentage and is one of the tools for evaluating performance relative to the amount invested. You can use ROI to determine if it's a good or bad investment. A higher ROI indicates a better investment.

Getting your head around investing is one thing, but how do you work out an investment return? 

Calculating ROI is relatively simple, using a formula. Take the net profit from the investment (total return minus the cost of investment) and divide it by the cost of investment. Then multiply that figure by 100 to express the ROI as a percentage.

For example, if you invest Rs. 10,000 in a stock, sell it for Rs. 12,000 a year later, and receive a dividend of Rs. 500, your total return is Rs. 12,500. The net profit would be Rs. 12,500 – Rs. 10,000 = Rs. 2,500. The ROI would then be (Rs. 2,500 / Rs. 10,000) x 100% = 25%.

Using ROI, you can keep track of how your investments perform and calculate which are more profitable.

Despite its usefulness, ROI does have some constraints.

First, it does not consider the time value of money, which changes over time due to factors such as inflation, opportunity cost, and the potential to earn a return on your investment.

Second, ROI does not account for risk. Some investments may have a high ROI but may also carry a higher risk of loss. This is why you should consider factors like risk, liquidity, and time horizons when evaluating an investment.

ROI offers a standardised way to track the performance of your investments. Here are some of the other reasons it can be useful.

ROI tells you how much money you've earned on an investment relative to what you invested. A higher ROI indicates a profitable investment, while a lower ROI indicates that it hasn't performed well.

With ROI, you can check and compare how different investments are performing. By calculating the ROI of multiple investments, you can choose the most profitable ones.

ROI allows investors to assess the potential return on an investment and determine whether it's worth the risk. You can make an informed decision about where to invest your money.

ROI is also a useful tool for evaluating the performance of an investment over time. By tracking the ROI you can decide if an investment is meeting your expectations and adjust as necessary.

In conclusion, ROI is a fundamental financial metric that can help you evaluate investment opportunities and make informed investment decisions.

By understanding how to calculate ROI and considering other factors such as risk and time horizons, you can optimise your returns and achieve your long-term financial goals.

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