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What is Return on Investment?

By Nathaniel P. Miller
Updated Feb 29, 2024
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A return on investment, also sometimes known in the financial world simply as an “ROI,” is the amount of money that a certain type of financial vehicle will yield over its lifetime. It’s basically a measurement of how much money an investor is likely to make should he or she invest in certain funds or bond accounts. In many cases, the ROI is “projected,” which means that it isn’t fixed. Things like stock fluctuations or other economic factors can change it. Investors who want a guaranteed return on their investments usually look to put money in vehicles that are very stable and that promise returns. As with so many things, though, it’s often the case that the biggest returns go hand in hand with the biggest risks.

General Concept

For many people, the whole point of contributing money to investment funds is to actually make some sort of profit over time. In addition to providing long-term savings for things like retirement, the majority of investments are also designed to grow over time, which means that people often withdraw more than they actually put in. The growth is usually referred to as a return.

There are a variety of financial vehicles that can be used to gain a reasonable return on investment. Stocks and bonds are typically what are thought of when considering investing; however, other vehicles, such as small business loans, precious metals, corporate bonds, and credit transactions can also provide more or less dependable rates of return.

The returns can be somewhat differently structured depending on the vehicle, though. With stocks, for instance, returns are usually governed by market forces outside of any individual’s control. Investors can make reasoned and researched predictions, but a lot is left to external forces. Bonds and loan funds are often fixed at various guaranteed return rates. The rates tend to be lower than what a person could earn on the open market — but they are also fixed, which means they’re definitely going to be realized. Understanding how ROIs are calculated and projected is often really helpful to people as they start exploring investment options.

Calculation Basics

Typically, return on investment is determined by dividing the amount of financial return from a specific investment vehicle by the total amount of monetary backing provided initially. For example, if an investor invested $20 US Dollars (USD) and got a return of $15 USD — for a total withdrawal of $35 USD — then he or she would divide 15 by 20 to get 0.75, or a 75% rate of return. The higher the rate of return, the greater amount of money an investor is receiving as either dividend returns or cash returns.

How the Return is Realized

Dividend returns are a specific type of ROI that entail all investors getting a guaranteed return on investment based on the success of the company and regardless of investment amount. As an example, a particular company may have a very successful year, and thus wants to extend dividend offerings of 1% of 10% of all profits to each investor. Therefore, each investor receives the same amount of return for investing in the company.

Cash returns are similar to dividend returns; however, each investor gets a different rate of return based on the amount of investment, also known as shares, that was provided initially. For instance, if a share of a particular company is valued at $5 USD on the open market and an investor purchases 100 shares at $500 USD but two weeks later the shares are worth $600 USD, that particular investor has a rate of return of 20% and a cash return of $100 USD. An investor who only purchased $100 USD worth of stock, however, will still get a 20% return, but only gain $20 USD cash back.

As a Means of Comparing Options

Investors often use known or projected ROIs as a means of comparing different funds before they decide where they want to invest. They will often look at various funds’ histories over a span of years, and will also consider projections about future sales and growth. Personal timelines and limitations also frequently factor in. Someone who is able to make a large investment and won’t need to withdraw for a long time, maybe 20 years, often has more options than someone with less money who anticipates needing it sooner.

Assessing the Risk

Most investments carry at least some degree of risk, and people are usually wise to think about how this risk could impact their return. Just because a fund has performed well in the past isn’t usually a guarantee that it will continue performing in the future. In many cases, ROIs are somewhat fluid, and investors who realize and anticipate this are less likely to be disappointed if things don’t work out as planned.

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Discussion Comments

By sneakers41 — On Oct 30, 2010

BrickBack-That is really true. Calculating return on investment requires detailed records because you have to study the correlation between the added expense and the bottom line profit.

You will have to ask yourself was there in increase in profits and revenues because of this purchase.

Sometimes when a company buys another company in efforts to grow their market, it may take time to truly understand the return on investment capital. Using a return on investment calculator really makes calculating the business return on investment easier.

By BrickBack — On Oct 30, 2010

Calculating return on investment is critical in business because you need to be able to understand how effective the return on investment formula is.

For example, if you are conducting a marketing return on investment, you will measure the effects of certain advertising media on your business.

You would look at the revenue on the days that you ran certain ads and determine if the ads should be increased or decreased or if another type of advertising media should be used.

Like all aspects of economics, there is a point of diminishing returns. This basically means that there will be a point in the advertising where there will be no additional gains as a result of the additional advertisements.

This takes time to develop because in the early stages of a business it is difficult to fully understand the return on investment analysis.

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