Return on investment (ROI) is a financial metric that is widely used to measure the probability of gaining a return from an investment. It is a ratio that compares the gain or loss from an investment relative to its cost. It is as useful in evaluating the potential return from a stand-alone investment as it is in comparing returns from several investments.

In business, the purpose of the return on investment (ROI) metric is to measure, per period, rates of return on money invested in an economic entity in order to decide whether or not to undertake an investment. It is also used as an indicator to compare different investments within a portfolio. The investment with the largest ROI is usually prioritized, even though the spread of ROI over the time period of an investment should also be taken into account.

ROI Formula

Total Amount Return - Total Invested Amount
Total Invested Amount

For example, Andy wants to calculate his ROI on his investment, he invested $ 100000, and total return amount is $ 130000, then,

$ 130000 - $ 100000
$ 100000
= 30%

Annualized Return on Investment (ROI)

The annualized ROI calculation provides a solution for one of the key limitations of the basic ROI calculation; the basic ROI calculation does not take into account the length of time that an investment is held, also referred to as the holding period.

Assume a hypothetical investment that generated an ROI of 50% over five years. The simple annual average ROI of 10%–which was obtained by dividing ROI by the holding period of five years–is only a rough approximation of annualized ROI. This is because it ignores the effects of compounding, which can make a significant difference over time. The longer the time period, the bigger the difference between the approximate annual average ROI, which is calculated by dividing the ROI by the holding period.