For a common person, Return on Investment or ROI depicts what you earn on your investments to help choose the best vehicle from the investment horizon. You evaluate the cost of investments based on your financial goals and risk tolerance. ROI is defined as the percentage ratio determining gain or loss from your investments against their cost. The ROI calculator simulates a positive or negative outcome in your intended investment.Read more
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ROI is one of the most common financial metrics used to evaluate an investment’s probability to gain returns. Though it is a ratio comparing gain or loss from an investment relative to its involved cost, it is expressed in percentage terms.
ROI and other cash flow measures are often the critical metrics in business analysis to evaluate and rank several attractive investment alternatives. In simple terms, ROI helps you decide whether to invest in a particular investment avenue keeping the chances of optimizing returns in mind.
Having understood the ROI fundamentals, let us learn its critical takeaways and scope in aiding your investment decisions.
ROI is an investment’s profitability approximation.
ROI’s wide application ranges in evaluating stock and real estate investments, among others.
ROI is computed by deducting the initial investment value from the final value to arrive at the net return. The computed net return is then divided by the investment cost and multiplied by 100 for the outcome ratio in percentage.
ROI is easy to comprehend and a universally accepted standardized profitability measure.
However, it does not reflect the holding period for comparing potential investments.
An ROI calculator is an online tool that helps evaluate returns from investments across different periods. You get the total amount accumulated using the primary inputs like the initial investment, returns, and investment period.
Moreover, the ROI calculator’s outcome displays absolute and annualized returns on investment, besides the CAGR or Compounded Annual Growth Rate.
You can comprehend how the ROI calculator works by first differentiating between the absolute return on investment and the annualized return on investment.
Let us explore them in greater detail.
Absolute Return on Investment: It measures stock investments for periods up to or less than one year. You can calculate the absolute value using the following formula:
ARI = (EVI – IVI) / IVI * 100
ARI - Absolute Value of Investment
EVI - End Value of Investment
IVI - Initial Value of Investment
Let us check it out with a live example:
EVI = Rs. 30,000
IVI = Rs. 25,000
Then ARI = (30,000 – 25,000) / 25,000 * 100
ARI = 20%
Annualized Return on Investment: When looking for an investment’s performance over varied holding periods, you must compute the annualized return on investment. Use the following formula for the outcome.
AR = (EV – BV) / BV * 100 * (1/Holding Period)
AR - Annualized Return
EV - End Value
BV - Beginning Value
Let us consider a live example:
BV = Rs. 30,000
EV = Rs. 50,000
Holding Period = 5 years
Then AR = (50,000 – 30,000) / 30,000 * 100 * (1/5)
AR = 13.33%
You can also annualize the absolute return on investment by multiplying with the following factors.
365 / investment held in days
12 / investment held in months
1 / investment held in years
Once you have understood different ROI calculations, it is a must to know how to use ROI calculators. Let us find out through the sequential steps described below:
Enter the investment amount.
Next, enter the return amount.
Enter the investment’s holding period.
The outcome is gain or return on your investment. In addition, you also get absolute and annualized returns on your investment.
Keep certain things in mind to make optimal use of the computed ROI. Let us check out.
ROI expressed in percentage is more straightforward to comprehend than in a typical ratio format.
ROI calculation reveals net return signifying returns as either positive or negative.
If the ROI is positive, the total returns exceed total costs and the net returns are black.
In contrast, your calculated net return is in the red if the ROI is negative because the total cost exceeds total returns.
You can accurately calculate ROI when considering total costs and total returns.
Consider annualized returns when comparing competing investments.
Some of the advantages offered by ROI calculators are:
User-friendly: Computation of the ROI needs no particular expertise. You can calculate the desired outcome by inputting the cost and the profit earned.
Global acceptance: The ROI calculating formula is universally used, and the outcome is globally accepted for its accuracy and simplicity. The results are easy to grasp, interpret, and implement.
Versatile application: You can put the calculated ROI to multiple uses. Understanding the scheme’s profitability and the comparative analysis of investment opportunities use extra financial values.
Like everything else, the ROI calculator too has its limitations. Here are some of them:
Time value: The ROI ignores money value relative to time. For example, you cannot compare a one-year return on FD with five-year returns in ELSS.
Ignores crucial factors: The ROI does consider impact due to several factors like inflation, processing, and stamp duty costs, to name a few.
Easily manipulated: You can manipulate ROI results easily and vary across investors. Therefore, you must use identical inputs to ensure accuracy.
The ROI calculator delivers a simple metric and insight into an investment’s profitability. However, despite relying on the actual output, you must still contend with its limitations. It is especially its failure to consider the impact of the holding period and the risk elements associated with an investment.
Nevertheless, notwithstanding the limitations, ROI is the most reliable financial metric for business analysts to evaluate and grade investment alternatives.
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