- ROI = (final value - total cost) ÷ total cost × 100.
- Include every cost and every return, such as fees and income received.
- Basic ROI ignores time. Annualize it to compare investments of different lengths.
- Use CAGR for a single lump sum over several years and IRR when cash flows are uneven.
The basic ROI formula
ROI = (final value - total cost) ÷ total cost × 100
The top of the fraction is the net gain, also called net profit. The bottom is everything you paid. The result is a percentage, which makes it easy to compare opportunities of different sizes.
- A positive ROI means you gained money.
- A negative ROI means you lost money.
- An ROI of 100% means you doubled your money.
ROI can describe a result that already happened or one you expect. For a planned investment the inputs are estimates, so the ROI is only as reliable as those estimates.
The same formula works for stocks, property, equipment, a marketing campaign or a training course. Only the definitions of cost and return change. The ROI calculator does the arithmetic for you.
Worked example
Simple version. You invest $10,000 and later sell for $12,500.
- Net gain = $12,500 - $10,000 = $2,500
- ROI = $2,500 ÷ $10,000 = 25%
Fuller version. Now include the details that the simple version left out. You paid a $200 fee to buy and a $300 fee to sell, and you received $400 of income while you held the investment.
| Item | Amount |
|---|---|
| Purchase price | $10,000 |
| Buying fee | $200 |
| Total cost | $10,200 |
| Sale price | $12,500 |
| Selling fee | -$300 |
| Income received | $400 |
| Total return | $12,600 |
Net gain = $12,600 - $10,200 = $2,400.
ROI = $2,400 ÷ $10,200 = 23.5%.
The fees lowered the result and the income raised it. The fuller version is the more honest number.
Annualized ROI and why time matters
Basic ROI has a blind spot. It says nothing about how long the gain took. A 25% return in one year is excellent. The same 25% over ten years is weak.
Annualized ROI fixes this by converting the total return into an equivalent yearly rate:
Annualized ROI = (1 + ROI) ^ (1 ÷ years) - 1
Write ROI as a decimal, so 25% is 0.25. The ^ symbol means "raised to the power of". For a 25% total return, the yearly rate depends heavily on the holding period:
| Total ROI | Years held | Annualized ROI |
|---|---|---|
| 25% | 1 | 25.0% |
| 25% | 2 | 11.8% |
| 25% | 3 | 7.7% |
| 25% | 5 | 4.6% |
Do not just divide the total by the number of years. For three years, 25% ÷ 3 = 8.3%, which overstates the true yearly rate of 7.7%. Dividing ignores compounding, the way each year's gain builds on the last.
ROI vs CAGR vs IRR
These three measures answer related questions. Each fits a different situation.
- ROI is the total gain as a percentage of cost. It is simple and ignores time. Use it for quick comparisons over the same period.
- CAGR, the compound annual growth rate, is the steady yearly rate that would turn a starting value into an ending value. It is the same calculation as annualized ROI. Use it for one lump sum held for several years. See the CAGR calculator.
- IRR, the internal rate of return, is the yearly rate that accounts for the size and timing of every cash flow. Use it when money goes in or comes out at several points, such as regular deposits, rent or staged project spending. See the IRR calculator.
A quick example: $10,000 that grows to $14,400 over two years has an ROI of 44% and a CAGR of 20%, because $10,000 × 1.2 × 1.2 = $14,400.
With a single amount in and a single amount out, CAGR and IRR give the same answer. They differ once there are cash flows along the way. For a closer look at IRR and its partner measure, read NPV vs IRR.
What to include in cost and return
ROI is only as good as its inputs. Count everything on both sides.
Costs to include:
- The purchase price
- Transaction fees, commissions and closing costs
- Ongoing costs such as maintenance, insurance, management fees and loan interest
- Improvements or upgrades made along the way
- Taxes owed on the gain, if you want an after-tax figure
Returns to include:
- The sale price or current market value
- Income received, such as dividends, interest or rent
- Savings the investment produced, for business projects such as new equipment
For business spending, the return is usually extra profit, not extra sales. If a $2,000 campaign brings $8,000 of sales at a 50% gross margin, the gain is $4,000 of gross profit minus the $2,000 cost. ROI is $2,000 ÷ $2,000 = 100%.
Common ROI mistakes
- Ignoring time. Comparing a 30% ROI over five years with a 20% ROI over one year without annualizing favors the wrong one.
- Leaving out costs. Fees, upkeep and interest are easy to forget and always lower the true return.
- Leaving out income. Dividends and rent are part of the return, even if the price did not move.
- Using revenue in place of profit. Sales are not gain until the cost of making them is removed.
- Ignoring risk. Two investments with the same ROI are not equal if one could easily have lost money.
- Ignoring inflation. A 3% return when prices rose 3% left buying power unchanged. The inflation calculator shows the effect.
- Mixing borrowed and own money. ROI on the cash you put in can look very different from ROI on the full purchase price. State which one you are using.
ROI describes what happened or what is expected under stated assumptions. It does not predict results.
Try it with your own numbers
- ROI CalculatorReturn on investment, total and per year.
- CAGR CalculatorSmoothed yearly growth between two values.
- IRR CalculatorThe yearly return a project really earns.
- NPV CalculatorA project's value in today's money.
Frequently asked questions
What is a good ROI?
It depends on the type of investment, the time involved and the risk taken. A return that looks high may not be attractive if it took many years or carried a real chance of loss. Compare the annualized figure with what similar investments of similar risk have returned, and with the rate of inflation.
Can ROI be negative?
Yes. If the final value plus any income is less than the total cost, the net gain is negative and so is the ROI. For example, paying $5,000 and ending with $4,000 gives a net loss of $1,000. Divide that by the $5,000 cost and the ROI is negative 20%.
What is the difference between ROI and annualized ROI?
ROI is the total percentage gain over the whole holding period, however long that was. Annualized ROI converts that total into an equivalent yearly rate using compounding. A 44% ROI over two years is an annualized ROI of 20%, because growing by 20% twice in a row gives 1.2 × 1.2 = 1.44.
How do I calculate ROI on a rental property?
Add up the annual rent, then subtract yearly costs such as maintenance, insurance, property taxes and management to get net income. Divide by the total amount invested, including purchase and closing costs. For a full picture over the holding period, also include the gain or loss in the value of the property when sold.
Sources and further reading
This guide is general education, not financial advice. Rules of thumb vary by lender, industry and country.