Understanding Return on Investment (ROI)
What is ROI?
Return on Investment (ROI) is a performance measure used to evaluate the efficiency or profitability of an investment. It directly measures the amount of return on a particular investment, relative to the investment's cost.
Components of ROI
- Initial Investment: The total amount you invest at the beginning
- Final Value: The total value of your investment after a certain period
- Net Profit/Loss: The difference between final value and initial investment
- Time Period: Duration of the investment (used for calculating annual ROI)
Understanding Annual ROI
Annual ROI helps normalize returns over different time periods, making investments comparable. It's calculated as:
When to Use ROI
- Comparing different investment options
- Evaluating the success of an investment
- Making business decisions
- Analyzing property investments
- Measuring marketing campaign effectiveness
Limitations of ROI
- Doesn't account for investment risk
- Time value of money not considered in basic ROI
- Different calculation methods can yield varying results
- Doesn't consider the scale of investment
Example Calculation
If you invest ₹100,000 and after 2 years it's worth ₹150,000:
- Total ROI = ((150,000 - 100,000) / 100,000) × 100% = 50%
- Annual ROI = (((150,000/100,000)^(1/2)) - 1) × 100% = 22.47%
- Net Profit = ₹50,000
Investment Wisdom
"The best investment you can make is in yourself."
— Warren Buffett
"ROI is not just about money. Time, energy, and effort are investments too."
— Investment Principle
