Return on Investment (ROI)
Net profit as a percentage of the capital invested. The universal yardstick for comparing investment performance.
ROI = (Net Profit / Cost of Investment) × 100
Return on Investment (ROI) measures the profitability of an investment relative to its cost. It is the simplest and most widely used metric for comparing the efficiency of different investments.
ROI does not account for time. A 50% ROI over 10 years is far less impressive than 50% in 1 year. To account for time, use annualized ROI or the CAGR (Compound Annual Growth Rate).
ROI also ignores risk. Two investments with the same ROI but different volatility are not equal — the risk-adjusted return (e.g. Sharpe ratio) gives a more complete picture.
On the desk
You invest $5,000 in a stock and sell it later for $6,500. Net profit = $1,500. ROI = ($1,500 / $5,000) × 100 = 30%. Compare that to a different trade where you made $300 on a $5,000 investment (6% ROI) — same dollar amounts deployed, very different results.