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What is ROI? How to Calculate Return On Investment?

What is ROI? How to Calculate Return On Investment?

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Investment and securities are subject to market risks. Please read all the related documents carefully before investing. The contents of this article are for informational purposes only, and not to be taken as a recommendation to buy or sell securities, mutual funds, or any other financial products.

While comparing investments, you might consider questions such as “What is a return on investment on a particular product?” or “What is a good return on investment?”. The return on investment or ROI is the ultimate objective of spending our money on anything at all. If an investment gives a good ROI, it has been successful. If it doesn't provide a good ROI, it has not yet succeeded. 

Let’s analyse ROI and understand how to calculate it.

What is ROI?

Return on Investment (ROI) is a financial metric used to assess the profitability of an investment in relation to its cost. It measures the gain or loss generated on an investment relative to the initial amount of money invested. ROI is expressed as a percentage and is used to evaluate the efficiency and effectiveness of different investments, projects, or initiatives.

  • For example, if you invested $1,000 in a stock and later sold it for $1,200, your net profit would be $200.
  • To calculate the ROI, you would divide the net profit by the initial investment ($200 / $1,000) and then multiply by 100 to express the result as a percentage.
  • In this case, the ROI would be 20%.

ROI is a crucial metric in assessing the attractiveness and potential profitability of different investment opportunities. It helps investors make informed decisions by comparing the returns from various investments and considering the associated risks. A positive ROI indicates that the investment has generated a profit, while a negative ROI suggests a loss.

The Return on investment formula

You can calculate the return on investment using the following formula: 

ROI = [(Current value of investment — Cost of the investment) / (Cost of the investment)]  X 100

The ROI is a positive percentage for gainful investments and a negative percentage for loss-making ones.

For example:

If you invested ₹10,000 in an equity mutual fund in the past and its value is ₹12,000 today, the ROI is [(12,000 — 10,000) / 10,000] X 100 = ₹20.

Are investments with the most ROI better?

If ROI is the ultimate objective of investments, shouldn't you invest all your investible corpus in an investment that gives the best ROI? Sounds simple, doesn’t it? But investments don’t work that way. No matter what the present ROI of an investment is, future market movements may not be predictable. 

Here’s why.

1. Markets may be volatile in the short to medium term

Unfortunately, no one can accurately predict the future ROI of all types of investments. This is especially true when it comes to equity and equity-based investments. These predictions can be made about the expected potential ROI based on market conditions and past performance. However, markets are dynamic, and the factors determining return on investment keep changing. Just like our thoughts and emotions change over days, the market is influenced by the thoughts and feelings of all the investors in the market collectively. 

2. Investing as per your investment plan

It is important for you to make investment decisions according to your investment plan. Your investment plan aligns your investments to your risk profile and your goals. Your risk profile measures your ability to take risks on your principal. It is a factor in your risk appetite and your risk tolerance. 

Another key component of investment planning is your goals. List them down as SMART goals. SMART stands for Specific, Measurable, Achievable, Relevant and Time-bound. Also, segregate them into goals to be achieved in the short, medium and long terms. The Fi money app can help you reach your financial goals through regular savings. You can create Jars for each goal and park your savings in short-term deposits or medium-term deposits to fulfil them.

  • Short-term goals have a time horizon of up to three years. An automobile, smartphone, home refurbishment and similar goals are short-term goals.
  • Medium-term goals are to be achieved within three to seven years. Medium-term goals may be a foreign vacation, a down payment for a new home, an art collection and such.
  • Long-term goals are those that are to be achieved beyond seven years. Goals like children’s higher education, second home and retirement corpus may be your long-term goals.

All asset classes are not considered to be equally volatile. Some are less volatile, while some are more volatile. Let us see how to use this in your investment planning. 

Relative volatility of asset classes

In the financial markets, risk and reward tend to go hand in hand. The higher the relative potential risk of an investment, the higher can be the relative expected potential reward. Similarly, investments with relatively lower risk can be expected to yield relatively lower returns.

Equity-based assets are considered high risk and high reward. Debt and commodity-based investments carry relatively lower risks and yield relatively lower returns. Investments with a blend or a balance of equities, commodities and debt are considered relatively medium risk and have the potential to yield relatively mid-range returns.Hence, you can match equity investments to long-term goals, debt-based investments to short-term goals and balanced and multi-asset investments to medium-term goals.

Equity, debt and multi-asset mutual funds are good ways to invest in these asset classes. You can invest in mutual funds easily on the Fi app. You can go for a Systematic Investment Plan (SIP) using FIT rules by completing your mandate and setting up your SIP date and amount. 

So, investing in asset classes with varying expected ROI for goals with varying time horizons is a good idea.

What is a good return on investment?

A positive ROI is what all investors are aiming for. But what is a good return on investment? The answer depends on the kind of investment and your purpose while investing.If you are investing for a short-term goal in a relatively less volatile asset class, even a relatively lesser ROI is a good ROI because the primary purpose of your investment here is to preserve capital over the short term rather than chase a large ROI.

Similarly, if you are investing for a long-term goal in a relatively more volatile asset class known for good long-term returns, a relatively higher ROI is a good ROI as your purpose here is high ROI over the long term.

ROI meaning in business

ROI is also used to measure the return on investment in a business. Here, instead of investing in a financial asset, you are investing in a business. The meaning and formula for calculating ROI are the same in business investment.

Summary

ROI is a measure of the profit or loss on an investment over the cost of the investment expressed as a percentage. Your investments can be spread across asset classes with varying expected ROIs to match your goals and risk profile according to your investment plan.

Frequently asked questions

1. What is an ROI example?

If you invested ₹10,000 in an equity mutual fund in the past and its value is ₹12,000 today, the ROI is [(12,000 — 10,000) / 10,000] X 100 = ₹20.

2. How to calculate ROI percentage?

To calculate ROI percentage, subtract the initial investment from the final value of the investment, then divide by the initial investment. Multiply the result by 100 to get the ROI percentage.

ROI Percentage = ((Final Value - Initial Investment) / Initial Investment) * 100

2. Is ROI profit?

ROI is not the same as profit. ROI measures the profit or loss on an investment expressed as a percentage of the investment.

3. Can ROI be negative?

Yes, ROI can be negative. In the unfortunate case that you have suffered a loss, your ROI value can decline and become negative. 

4. What are the various methods of measurement of return on investment?

There are various methods of measuring return on investments. Here are some commonly used methods:

  1. Absolute Return: This measures the actual gain or loss on an investment in monetary terms, without considering any other factors.
  2. Percentage Return: It calculates the return on investment as a percentage of the initial investment amount.
  3. Time-Weighted Return: This method accounts for the impact of cash flows and measures the performance of an investment over a specific period, regardless of when cash inflows or outflows occur.
  4. Money-Weighted Return: Also known as the internal rate of return (IRR), this method incorporates the timing and amount of cash flows to calculate the overall return on an investment.
  5. Total Return: It considers both the capital appreciation of the investment and any income generated, such as dividends or interest, over a specific period.
  6. Holding Period Return: It measures the return on investment over the period during which the investment is held.
  7. Risk-Adjusted Return: This method factors in the level of risk associated with an investment to assess its return, taking into account factors such as volatility or market fluctuations.
  8. Dividend Yield: It calculates the return generated by dividends as a percentage of the current market price of an investment.
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