Return on Investment (ROI): How to Measure What Your Money Earns

ROI is one of the most used terms in the world of money, and one of the most misused. People throw the number around to sound impressive, often leaving out the one detail that gives it meaning. This short guide explains what ROI really is, how to calculate it properly, and how to tell whether an ROI is actually good.

What is ROI

ROI stands for Return on Investment. It measures how much you gained, or lost, relative to the amount you put in. It is the most basic answer to the question every investor asks: was this worth it?

ROI is expressed as a percentage, which is what makes it useful. A gain of ₹50,000 means very little on its own. A gain of ₹50,000 on an investment of ₹1,00,000 is a 50 percent ROI, and now you can compare it with anything else.

How to calculate ROI

The basic ROI formula is simple:

ROI = (Final value minus Amount invested) divided by Amount invested, multiplied by 100

If you invest ₹2,00,000 and it grows to ₹3,00,000, your gain is ₹1,00,000. Divide that by the ₹2,00,000 you invested, and you get 0.5, or a 50 percent ROI. Our ROI calculator does this instantly, and also handles the more important version we are about to discuss.

The detail everyone forgets: time

Here is the catch with the basic ROI figure. It says nothing about how long the money took to earn that return. And without time, the number is close to meaningless.

A 50 percent ROI earned in 2 years is excellent. The exact same 50 percent ROI earned over 15 years is poor, barely keeping ahead of inflation. The percentage is identical. The investments are worlds apart. This is why a bare ROI figure, with no time period, should always make you suspicious.

Absolute ROI versus annualised ROI

Because of the time problem, there are really two versions of ROI, and you need both.

• Absolute ROI is the simple total percentage gain, the figure from the formula above. It tells you the overall result but ignores time.
• Annualised ROI spreads that gain evenly across each year of the holding period. It is the same idea as CAGR, the compound annual growth rate. This is the figure that lets you compare investments fairly.

For investments made through many instalments, such as a SIP, even annualised ROI is not enough, because the instalments went in on different dates. There you need XIRR. Our guide on CAGR vs XIRR covers that fully.

How to judge whether an ROI is good

A good ROI is never an absolute number. It is always relative. Once you have a proper annualised ROI, judge it against four things:

• Inflation. If your annualised ROI after tax does not beat inflation, your wealth has not really grown. See our inflation guide.
• A safe alternative. If a risky investment's ROI is barely above a fixed deposit's, the risk was not rewarded.
• The risk you took. A high ROI from a very risky bet is not the same as a steady ROI from a sensible one. Always weigh return against risk.
• Your goal. Ultimately, a good ROI is one that is enough to get you to your goal in the time you have.

ROI beyond investments

ROI is a flexible idea. It applies to more than mutual funds and stocks. You can think in ROI terms about prepaying a loan, where the return equals the interest rate you save, or about spending on a skill or course that raises your earning power. Thinking in ROI trains you to ask, of any use of money, what does this give back, and over what period.

ROI answers a simple question honestly only when you attach time to it. A percentage without a period is a number pretending to be an answer.

Use the ROI calculator to find both the absolute and the annualised ROI of any investment. The annualised figure is the one to trust, and the one to compare.