What is Return on Investment (ROI)?

Return on Investment (ROI) is a performance measure used to evaluate the efficiency or profitability of an investment or compare the efficiency of a number of different investments. In simple terms, ROI measures the amount of return on a particular investment, relative to the investment's cost. A high ROI means the investment's gains compare favorably to its cost. As a performance measure, ROI is used to evaluate the efficiency of a standalone investment. It is one of the most common financial metrics used by investors, business owners, and financial analysts.

The Basic ROI Formula

Calculating the basic ROI is straightforward. It shows the total gain or loss as a percentage of the initial cost.

Net Profit = Final Value of Investment - Initial Investment

ROI (%) = (Net Profit / Initial Investment) × 100

For example, if you invest ₹1,00,000 and the investment grows to ₹1,50,000:

• Net Profit: ₹1,50,000 - ₹1,00,000 = ₹50,000
• ROI: (₹50,000 / ₹1,00,000) × 100 = 50%

This tells you that your investment generated a 50% return over its entire lifetime.

The Limitation of Basic ROI and the Need for Annualization

The biggest limitation of the basic ROI formula is that it does not account for the holding period of an investment. A 50% ROI sounds great, but it's much more impressive if it was achieved in one year than if it took ten years. Without considering the time factor, you cannot accurately compare the performance of different investments.

This is where Annualized ROI, also known as the Compound Annual Growth Rate (CAGR), becomes essential. It calculates the average annual rate of return that an investment has generated over a specific period, assuming the profits were reinvested each year. It provides a standardized "apples-to-apples" comparison metric.

The Annualized ROI (CAGR) Formula

Annualized ROI (%) = [ (Final Value / Initial Investment)^{(1 / Number of Years)} - 1 ] × 100

Using our previous example, if the 50% return was achieved over 5 years, the Annualized ROI would be approximately 8.45%. If it was achieved in just 2 years, the Annualized ROI would be 22.47%. Our calculator performs this complex calculation for you, giving you a true measure of your investment's yearly performance.

What is a "Good" ROI?

There is no single answer to this question. A "good" ROI is highly dependent on the type of investment, its associated risk, and the investment horizon.

• Low-Risk Investments: For very safe investments like Fixed Deposits (FDs) or government bonds, a "good" ROI might be in the range of 6-8% annually.
• Moderate-Risk Investments: For mutual funds or blue-chip stocks, investors often look for an annualized ROI of 12-15% over the long term to beat inflation and generate wealth.
• High-Risk Investments: For venture capital, small-cap stocks, or cryptocurrencies, investors might target a much higher ROI to compensate for the significantly higher risk of losing their capital.

The key is to compare an investment's ROI to the benchmark for its asset class and its level of risk.

Frequently Asked Questions (FAQs)

1. How do I use the Investment ROI Calculator?

Enter the initial amount you invested, the final value of that investment, and the start and end dates of the investment period. The calculator will automatically provide the net profit, the total ROI, and the more important Annualized ROI.

2. Does this calculator account for additional investments or withdrawals?

No. This is a simple ROI calculator designed to measure the return on a single, lump-sum investment. It does not account for multiple contributions or withdrawals over time. For such scenarios, a more complex calculation method like XIRR (Extended Internal Rate of Return) would be needed.

3. Why is Annualized ROI sometimes lower than the total ROI?

Total ROI shows the return over the entire period. Annualized ROI shows the average yearly return. If your investment period is longer than one year, the annualized ROI will naturally be lower than the total ROI because it "smooths out" the total gain over the number of years the investment was held.

4. Does ROI account for risk?

No, this is another key limitation of ROI. It only measures return, not the risk taken to achieve that return. An investment with a 20% ROI might seem better than one with a 10% ROI, but if the first investment was extremely risky and the second was very safe, the 10% return might be the more attractive option for many investors. Always consider risk alongside ROI.