How to calculate return on investment, step by step
Return on investment is one number that answers one question: what did you gain on the money you put in, as a share of what you put in? The calculation needs three numbers: your initial investment, your final value and your holding period. On $10,000 invested for 3 years and now worth $13,000, the profit is $3,000, the return on investment is 30% and the annualized ROI is 9.14% a year, not a value in dollars, and it is below 100% because the investment gained less than the whole amount put in. So the return on investment is the profit divided by the initial investment, times 100.
The definition is the gain on the money you put in: the final value minus the initial investment is the profit, and the profit divided by the initial investment is the ROI. The initial investment is everything you paid — not just the price, but the fees, the commissions and the taxes on the way in. The final value is what the investment is worth now, or what you sold it for — after the costs of selling, if there were any. If you leave a cost out of the initial investment, the ROI looks better than it is, and the decision that follows is built on a number that is not honest.
The worked example, line by line. Step 1 — the profit: $13,000 − $10,000 = $3,000. Step 2 — the return on investment: $3,000 ÷ $10,000 × 100 = 30%. Step 3 — the annualized ROI: ($13,000 ÷ $10,000)1 ÷ 3 − 1, × 100 = 9.14% a year. Work it yourself in the return on investment calculator.
A note on the rounding: the figures are displayed to two decimals, half-up. The profit is $3,000 exactly and the ROI is 30.00% exactly, so nothing is lost to rounding on the defaults. The annualized ROI is 9.14% displayed and 9.139288% unrounded — with fractional inputs it can land a hair either side of a round number, and the calculator prints the unrounded figure so the rounding does not mislead you.
What the answer means
A return on investment of 30% means the investment gained $3,000 on $10,000 put in — for every dollar invested, thirty cents came back as profit. That $3,000 has to cover everything the investment cost to hold: the fees, the tax on the gain and the time the money was tied up, and whatever is left is the gain that counts. An annualized ROI of 9.14% a year means the steady yearly rate that would turn $10,000 into $13,000 in 3 years is 9.14% — the investment did not necessarily grow 9.14% every year, and the annualized figure smooths an uneven path into one number. A 9.14% yearly rate beats most savings accounts and roughly matches long-run stock market returns, but a higher ROI usually means higher risk, so compare your ROI to what the money would have earned elsewhere, at the same risk.
When there is no annualized ROI
Some investments have no annualized ROI, and the honest answer is that it is undefined. With a holding period of 0 years there is no yearly rate to annualize to — the ROI is still 30% and the profit is still $3,000, but there is no time for a yearly rate to exist — and the calculator says so plainly. An investment held for no time has no yearly return to report, whatever its gain is. The same holds when the initial investment is nothing: with no money put in there is nothing to divide by, and there is no ROI at all. In each case the calculator shows the figure instead of hiding it.
ROI vs annualized ROI
The return on investment and the annualized ROI answer different questions, and mixing them up is the most common mistake. The ROI is the total gain — 30% here. The annualized ROI is the gain as a yearly rate — 9.14% a year here. One is a total, the other is a rate. The same 30% gain is 30.00% a year over 1 year, 9.14% a year over 3 years, 5.39% a year over 5 years and 2.66% a year over 10 years — the longer the money takes to gain 30%, the less it is worth a year. Use the ROI when you want the total gain, and use the annualized ROI when you want to compare investments held for different lengths of time. Work it out in the return on investment calculator.
ROI vs profit
The return on investment and the profit answer different questions too. The profit is the gain in dollars — $3,000 here. The ROI is the gain as a share of the cost — 30% here. One is money, the other is a percentage. A $3,000 profit on $10,000 is a 30% ROI, but the same $3,000 profit on $100,000 is only a 3% ROI — the profit alone does not tell you whether the investment did well. Use the profit when you want the dollars, and use the ROI when you want the efficiency. Work it out in the return on investment calculator.
Common mistakes
The first mistake is leaving costs out of the initial investment — only the full amount paid counts toward the ROI, so add the fees, the commissions and the taxes, not just the price. The second is comparing total ROIs across different holding periods — a 30% gain over 3 years and a 30% gain over 10 years are not the same investment, so annualize before you compare. The third is forgetting that the annualized ROI is a smoothed rate — the investment did not grow 9.14% every year, and a single bad year can hide inside a good annualized figure. The fourth is counting money added along the way as part of the gain — new deposits are not profit, and counting them inflates the ROI. Work it out in the return on investment calculator, and check the payback period calculator and the compound interest calculator before you decide what the answer means.