It’s easy to pick various things to invest in from the market, but how do you know if you’re actually making any money? Calculating your return on investment, or ROI, is the best way to come up with the earnings. But here’s the thing. Sometimes it’s more challenging to figure out the return than just looking at it.
There are calculations to help determine your ROI. On the same note, there are also indicators that you can monitor to determine whether or not your return on investment is actually good. Check out the full details below.
ROI Explained
ROI stands for return on investment.
In short, it’s a way to determine how much your investment is making you. You could find an ROI calculator online, but it’s not too complicated to learn how to calculate on your own as well.
The ROI is determined by figuring out any profit or loss from the investment and then using that number and the cost of the investment to figure out the earnings. ROI calculations are percentages so you determine the % that your investment has returned when complete.
The goal of ROI? To determine how much profit (or loss) you experienced with said investment.
ROI Calculation
In order to complete the calculation, you really just need to know your net profit or net loss on a specific investment, as well as the original cost and the current value of the investment. There are two different methods that can be used to figure up your ROI.
The first is to simply take the net profit and divide it by the cost of investment. The formula looks like this.
ROI = (Net Profit/Cost of Investment) x100
Here’s an example. If your net profit was £100 and your cost of investment was £2000, you would take 100/2000 and then x100 to get your percentage. That’s an ROI of 5%.
The other formula you could use if you want is to take the present value and the cost of investment and go through the formula process. That looks like this.
ROI – (Current Value – Cost of Investment/Cost of Investment) x100
So here, we would assume your value is now £2100. Subtract £2000 from that as your cost of investment and you have £100. Divide by the cost of investment and take that number x100 to get your percentage, which should be 5%.
Notice that these come out with the same number, it’s just two different ways to get there. When you’re looking at value, you might also have things like dividends and capital gains to work into the number. There might also be fees that are part of the cost of investment. You can add those details in if you need to.
What is a Good ROI?
This question is a bit more challenging than just learning how to determine ROI and what it means for you. The truth is that every investor is going to have a different definition of what is good for their return on investment.
Someone who is just getting started and has plenty of time to grow their accounts might be impressed with 2-4% ROI, while someone closer to retirement age would more likely prefer much higher percentages.
It’s not a one size fits all answer.
Most of the time, higher risk investments will have higher returns. That being said, they also can have much higher losses because of the risk factors associated with them. The best way to gauge a good return on your investment is to determine the average of a specific market.
For example, the average annual return on stocks in general is about 14%. So, if you’re purchasing stocks, this will be your target number to know whether you’re at least making the average.
Here are a few other category averages as well.
- Bonds 5%
- International Stocks 6%
- Treasury Bills 4%
- Gold 1%
- Real Estate 8%
- CDs 1%
These are just average numbers taken from statistics of returns through an annualized period. This can be a good marking place to know if your ROI is average, better than average, or even below average. It’s a great way to track and know.
Over time, the ROI should be much larger, which is often true of things like bonds, CDs, and other long-term investments. That being said, there is no guarantee of a higher return so keep that in mind.
Short Term ROI Vs Long Term ROI
There are some investment strategies that take a long-term approach, while others are meant to be short-term. The strategy that you use will impact the return that you experience. It’s also important to note that while your short-term ROI might only be 3%, your long-term ROI in a certain investment could far exceed that.
The thing with investments is there is simply no guarantee when it comes to ROI. However, you should know that you will see a significant difference when it comes to short term and long term investments.
Short Term ROI
Short-term investments are investments that you might utilize or access in a year or less. This includes some CDs but also includes things like savings accounts, money markets, T-bills, and other similar investments.
These investments are more liquid, and more available to you on an as-needed basis.
Because of that, they often return much lower rates. It’s not that they aren’t good deposits, it’s just that they are short-term and their ROI reflects that. The idea is that you won’t have to wait to grab that cash if you need it.
It’s very similar to a cash position in that way, but it pays at least some return, as opposed to nothing.
Long Term ROI
In contrast, long term investments are the ones that you invest in and intend to hold for the long haul. These investments are going to be more like mutual funds, target-dated mutual funds, stocks, real estate, bonds, and other similar entities.
These are meant to be held onto and are not liquid like cash assets. The idea is to invest in these items and then leave it there for a long time. Over time, the earnings add up, providing you with significant ROI in general. There are some stocks and investments that fail. There are also some that see downturns and never recover.
These are the risks of such investments.
Typically, these items fluctuate with their relative markets, moving up and down in cyclical nature. Hopefully, in the end, you see significant ROI, growth, and gain on your long-term investments. Keep in mind this is never guaranteed, though.
Not All Investments Will Always Have Great ROI
While you can run these calculations and determine your ROI, it doesn’t make or break your investment. Just as you can look at the average of a specific sector and figure out if you’re hitting the average or not.
Yes, the average, or in some cases the index, is your target, but you won’t always beat that. There will be years you see ROIs that are lower. And then there will be times you see ROIs that are higher.
The question is, do you have the stomach for the roller coaster?
If you’re investing for long-term practices, it’s much better to not panic when you do see lower than average returns. Sometimes you will have outstanding ROIs and other times you might be cringing. This is the game of the investment market.
Final Thoughts
What really is a great ROI? Well, it depends. Your goals will be different, as will your investments. The true answer is that every investor will have a different idea of what constitutes a great ROI. You can use average sector ROIs as a marker, but remember that the market fluctuates and you won’t always beat that average.
What type of investor are you?
Related Guides:
