Return on Investment (ROI) measures how much profit or loss an investment generates relative to its cost. The formula is: ROI = (Net Profit ÷ Cost) × 100.
Example
You invest $5,000 and sell for $6,500. ROI = ($1,500 ÷ $5,000) × 100 = 30%.
Limitations
Simple ROI does not account for time. A 30% return over 5 years is very different from 30% in 6 months. Use annualized ROI for fair comparisons across different holding periods.
Annualized ROI
To compare investments held for different lengths of time, convert to an annualized (CAGR) basis: Annualized ROI = (1 + Total ROI)^(1/years) − 1. A 30% total return over 5 years annualizes to about 5.4%/year — much less impressive than a 30% return earned in a single year, even though the raw ROI percentage is identical.
ROI Doesn't Account for Risk
Two investments with the same ROI aren't necessarily equally good — a 10% return from a volatile stock and a 10% return from a government bond carry very different risk. Metrics like the Sharpe ratio adjust returns for the volatility taken on to earn them, which is why professional investors rarely look at ROI in isolation.