What is ROI and how is it calculated?

What is ROI and how is it calculated?

In an investment there is a very important metric to determine if it is doing well or not: ROI. ROI significa Return of Investment, that is, return on investment for its acronym in English, and it must be taken into account when making an investment.

ROI determines the return on the specific investment versus its cost. Therefore, it is a relative measure, and not an absolute measure, of how good or bad the investment is doing. Today we deal with this topic in our Concepts of Economics.

ROI calculation

To calculate the ROI, you just have to divide the return on the investment, that is, the value of the investment today minus the cost of the investment, by the cost of the investment. Therefore the value of ROI is expressed as a percentage.

ROI = (valor de inversión a día de hoy - coste de la inversión)/coste de la inversión

By expressing the ROI a percentage allows a comparison to be made between different investments, regardless of the amounts contributed to each of them. Therefore, being clear about the different ROIs of investments allows us to see which ones are better.

For example, if 1,000 euros are invested in shares and after a while the value of these shares is 1,500 euros, the ROI of said investment would be 50% (ROI = (1500-1000) / 1000).

ROI advantages and disadvantages

ROI has clear advantages. The first is that it is quite easy to calculate and allows you to quickly see how good or bad the investment has been, being able to have a benchmark or comparison between different investments.

Plus just looking at the ROI sign it can be determined whether the investment has been a profit or a loss, which is essential when controlling investments. Therefore, the ROI is a simple tool but not for that little powerful.

However, ROI has some drawbacks. The main one is that does not include the time frame. That is, it is not the same to have an ROI of 50% in one year than in ten years. And the ROI does not contemplate this possibility, it would be necessary to go to other indicators. And it does not take inflation into account either, and it is not the same to have an ROI of 3% in a year with 0% inflation or 5% inflation.

Therefore, ROI is a very useful indicator to understand the return on an investment, it is simple and easy to understand, but it is not the only one that determines if the investment is good or not.

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The news

What is ROI and how is it calculated?

was originally published in

The Salmon Blog

by Alejandro Nieto González.

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