What Is ROI? The Formula, Worked Examples, Annualizing, and ROAS vs. Yield

Have you ever heard phrases like "this campaign has an ROI of 150%" or "let's compare them by ROI" in a business meeting or an investing explainer? ROI is the most basic and widely applicable metric for expressing, as a single ratio, how much profit you earned relative to the money you put in. This article explains, step by step, what ROI is, how to calculate it, and what to watch out for when using it.

What Is ROI

ROI (Return On Investment) is a metric that shows how much profit (return) you obtained relative to the amount you invested. It is usually expressed as a percentage (%).

The appeal of ROI is that it lets you compare investments of different sizes and kinds with the same ruler, a "rate." For example, an ad that costs 100 dollars and equipment that costs 100,000 dollars cannot be meaningfully compared by the raw amount of profit alone. But converted into the ratio that is ROI, you can line them up from a shared viewpoint: "how much did I earn per dollar invested?" It is used not only for financial investments such as stocks and real estate, but also to measure the cost-effectiveness of all kinds of spending, including ad campaigns, equipment, and staff training.

To get a feel for it with concrete numbers, it is easiest to enter an investment amount and a recovered amount in the ROI Calculator and try a few times to see how the ROI changes.

The ROI Formula and Worked Examples

The ROI formula is very simple.

ROI (%) = profit ÷ investment × 100

Here, profit means the "pure gain," the amount obtained from the investment minus the amount invested. In other words, "profit = recovered amount (total return) − investment." Using this, the formula can also be written as follows.

ROI (%) = (recovered amount − investment) ÷ investment × 100

Let us plug in real numbers. Suppose you invest 1,000 dollars and ultimately recover 1,300 dollars. The profit is 1,300 − 1,000 = 300 dollars, so the ROI is found as follows.

• Profit: 1,300 − 1,000 = 300 dollars
• ROI: 300 ÷ 1,000 × 100 = 30%

This 30% means "a gain of three-tenths was made on the 1,000 dollars invested." If the recovered amount were 900 dollars, the profit would be −100 dollars, the ROI would be −10%, indicating a loss. ROI is intuitive: positive means profit, negative means loss. Note that if you already know the "profit" itself instead of the recovered amount, you put the profit directly in the numerator. When you want to line up and compare the ROI of several cases, entering each set of figures in the ROI Calculator lets you check them quickly.

Annualized Return Over a Holding Period

ROI has one major weakness: it does not account for "over what period the profit was earned." For example, the same "ROI 30%" is a completely different proposition depending on whether you achieved it in one year or over ten years. Thirty percent in one year is excellent, but 30% over ten years is tiny on a per-year basis.

To compare different periods fairly, we use the idea of an annualized return, ROI converted to a per-year basis. There is a simple way of dividing by the number of years ("ROI ÷ years"), but more accurately we account for compounding and think in terms of a compound annual growth rate (CAGR) that reflects profit earning further profit.

Annualized return (%) = ((recovered amount ÷ investment) ^ (1 ÷ years) − 1) × 100

Consider the earlier "1,000 → 1,300" example. If you achieve it in one year, the annual rate is 30%, but if you achieve the same result over five years, the annualized return falls to about 5.4%. Even though the total ROI is the same 30%, factoring in the cost of time changes the evaluation greatly. When you want to project "how much it will become in the end" with compounding for a long-term investment, simulating with different rates and years in the Compound Interest Calculator lets you feel the impact of time on profit.

Conversely, when you want to know how much a given annual rate (yield) will grow to in the future, the Compound Interest Calculator is also useful. We recommend using both wheels: ROI to look back on past results, and compound interest to look ahead to the future.

How ROI Differs From ROAS and Yield

Two metrics often confused with ROI are ROAS and yield. They seem similar but look at different things.

ROAS (Return On Advertising Spend) is the ratio of revenue to ad spend. Whereas ROI looks at "profit (after subtracting cost)," ROAS looks at "revenue (before subtracting cost)." Because of this, even when ROAS is high, if the cost of goods and expenses are large, the profit can be thin and the ROI low. Use ROAS to measure advertising efficiency, and ROI to measure whether the business is actually profitable; their roles differ.

Yield closely resembles ROI in that it is the ratio of income to the invested amount, but by convention it is almost always expressed on a per-year basis. The annualized return mentioned in the previous section can be seen as ROI divided back over the period into the form of a yield. In short, it is clearest to organize it as "ROI is the overall rate without fixing a period, and yield is the rate normalized to one year."

Using ROI in Investment Decisions

ROI is helpful in decision-making for investing and business in situations like the following.

1. Comparing multiple options

When you are unsure where to spend a limited budget, calculating the (projected) ROI of each candidate and lining them up reveals the most cost-effective option. A strength of ROI is that you can compare investments of different natures, such as Ad A, Ad B, and a new service, with the same ruler.

2. Verifying the effect after the fact

After carrying out an initiative or investment, reviewing "whether you actually achieved the projected ROI" improves the accuracy of your next decision. Comparing the pre-ROI and the post-ROI is good material for learning what worked and what missed.

When comparing or verifying, entering several cases into the ROI Calculator to line up the numbers, and annualizing with the Compound Interest Calculator as needed, makes the judgment much easier.

The Limits and Caveats of ROI

Useful as it is, ROI does not decide the merit of an investment all on its own. It is important to use it with an understanding of the following limits.

• It does not include time: as noted, the same ROI has different value depending on how long it took to achieve. When comparing long and short periods, convert to an annual rate.
• It does not reflect risk: ROI shows only the resulting rate, not how uncertain (risky) the investment was. A high ROI may still come from an investment with a high chance of loss.
• It changes with what you include as profit and investment: ROI moves greatly depending on whether you include fees, taxes, and labor costs. When comparing, it is essential to align the assumptions of the calculation.

ROI is a powerful metric that shows the ratio of gain to the money invested in a single number, letting you compare investments of different sizes side by side. At the same time, important factors such as time and risk must be considered separately. Start by calculating familiar numbers in the ROI Calculator, and check the long-term outlook with the Compound Interest Calculator. Actually moving the numbers is the shortcut to building intuition.

Please note that this article is intended to provide general information and does not recommend or advise any specific investment. Investing involves risk, and results are not guaranteed. When making an actual investment decision, check the latest official information, consult a professional if necessary, and act at your own responsibility.