What It Means
Return on investment (ROI) measures how much an investment gained or lost compared with what it cost. You subtract the total cost from what the investment returned, divide by the total cost, and multiply by 100 to get a percentage. An ROI of 1010,000 stepsA popular daily step goal that began as the name of a 1960s Japanese pedometer; later studies find health benefits begin well below it. See more% means each dollar put in earned 10 cents on top of itself. The simple version says nothing about how long that took, so investments held for different lengths of time are compared with an annualized figure instead.
Try It: Work Out Simple and Annualized ROI
Example numbers: a $5,000 piece of equipment that brought in $6,500 over three years. Put in your own.
Each $1 put in came back as in total.
It broke even: exactly what went in came back.
It lost money: less came back than went in.
Simple ROI ignores time. The annualized figure lets you set this against an investment held for a different number of years.
How People Say It at Work
- "What's the ROI on the new oven?"
- "The ad paid for itself, but the ROI was thin."
- "Show me the ROI before we sign."
The Breakdown
Formula
ROI = (total returned minus total cost) ÷ total cost × 100
Harvard Business School Online describes the same thing for a project: the income it brings in minus its costs gives the net profitNet incomeWhat's left after everything is taken out: on a paycheck, pay after taxes and deductions; for a business, profit after all expenses and taxes. See more, and net profit divided by cost, times 100, is the ROI.
Worked example. A small bakery buys a $5,000 mixer (example numbers). Over three years the extra orders it makes possible bring in $6,500.
| Step | Amount |
|---|---|
| Total returned | $6,500 |
| Total cost | $5,000 |
| Gain | $1,500 |
| ROI, $1,500 ÷ $5,000 × 100 | 30% |
Adding time. Thirty percent over three years isn't the same as 30% in one year. Fidelity points to the compound annual growth rate (CAGR) for putting investments of different lengths side by side:
Annualized ROI = (total returned ÷ total cost) raised to the power of (1 ÷ years), minus 1, times 100
For the mixer, 1.3 raised to the power of 1/3 is about 1.091, so the annualized ROI is about 9.1% a year. A different option that returned 20% in a single year beats it, even though 20 is a smaller number than 30.
What the result means. The 30% says the mixer paid back its price plus 30 cents on every dollar. The annualized 9.1% is the figure to set against other ways the bakery could have used $5,000 over the same three years.
Good to Know
ROI is only as good as the costs you count. Fidelity's formula uses the investment's total cost, so fold in fees, delivery, installation and upkeep, along with the purchase price. For a personal investment decision, the numbers here are arithmetic, and a licensed financial professional can help weigh risk and taxes, which ROI leaves out.
FAQ
How do you calculate ROI?
Subtract the total cost from what the investment returned, divide by the total cost, and multiply by 100. Spending $5,000 to get back $6,500 is a 30% ROI.
What does a 10% ROI mean?
It means each dollar invested earned 10 cents on top of itself, as Fidelity explains it. On $1,000, that's $100 of gain.
What's the difference between ROI and annualized ROI?
Simple ROI covers the whole time you held the investment, however long that was. Annualized ROI spreads the result over the years involved, the compound annual growth rate Fidelity describes, so a three-year investment and a one-year investment can be compared fairly.
Do It in Buhata
Budget in a separate Space
Set up a separate Space for the project in Buhata and log every cost and every dollar it brings in to Budget there, so your ROI uses real totals.
Open BuhataRelated Terms and Categories
- Return on ad spend (ROAS)
The revenue, or other conversion value, that ads bring in divided by what the ads cost, shown as a ratio or a percentage.
- Customer lifetime value (LTV)
The total revenue a business expects to earn from one customer over the whole time that customer keeps buying.
- Compound interest
Interest paid on your original amount and on the interest it has already earned, so each year's interest is a little bigger than the last.
Sources
Fidelity, "How to calculate ROI"; Fidelity, "What is return on investment (ROI)?"; Harvard Business School Online, "How to Calculate ROI to Justify a Project"
- www.fidelity.com/learning-center/smart-money/how-to-calculate-ROI
- www.fidelity.com/learning-center/trading-investing/ROI-return-on-investment
- online.hbs.edu/blog/post/how-to-calculate-roi-for-a-project
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