How to calculate ROI — formula, examples, pitfalls
Return on Investment is the simplest return metric in finance — and the one most often misused. Computing ROI correctly avoids three classic traps: ignoring time, ignoring inflation, and confusing pre-tax with after-tax returns. This guide gives you the formula, three concrete examples, and tells you when to use CAGR or IRR instead.
“Net profit” = sale proceeds minus cost basis — i.e. the gross gain before tax. ROI is conventionally expressed as a percentage. Important: the formula carries no time dimension — a 30 % ROI in one year is very different from 30 % ROI over ten years.
Example 1: Stock purchase
You buy 100 shares at $50 (cost $5,000) and sell two years later at $65 (proceeds $6,500). Along the way you collected $200 in dividends.
Calculation: (1,700 / 5,000) × 100 = 34 % over 2 years. Annualized that’s roughly 15.8 % p.a. — annualization formula: (1 + ROI)^(1/years) − 1.
Example 2: Real-estate investment
You buy a rental property for $250,000, financing $200,000 of it (your equity contribution = $50,000). Ten years later you sell for $320,000. Over the holding period you collected $60,000 in rent and paid $40,000 in interest, maintenance and taxes.
Annualized that’s roughly ~10.9 % p.a. on equity — leverage explains a large part of the headline number. Without leverage ($250,000 cash) it would be ~36 % ROI = ~3.1 % p.a.
ROI vs. CAGR vs. IRR
| Metric | What it measures | When to use |
|---|---|---|
| ROI | Total return over the holding period (%) | Single investment, no time comparison |
| CAGR | Annualized growth rate (geometric) | Multi-year comparison between investments |
| IRR | Annualized return with intermediate cash flows | DCA plans, real estate with rents |
| TWR | Time-weighted return | Evaluating a manager’s performance |
Rule of thumb: for “did I make money?” ROI is enough. As soon as you compare investments or have intermediate cash flows, IRR or CAGR is more accurate.
Pros and cons of ROI as a metric
- Very simple to compute
- Direct comparison between investments
- Universally applicable — equities, real estate, marketing
- Easy to communicate to non-finance audiences
- Ignores time — 30 % in 1 year ≠ 30 % in 10
- Ignores inflation — real return can be negative
- Pre-tax — after-tax ROI is meaningfully lower
- Ignores risk — Sharpe ratio is better for that
Frequently asked questions
How do I convert ROI into an annual return?
Use (1 + ROI/100)^(1/years) − 1. Example: 50 % ROI over 5 years = (1.5)^0.2 − 1 = 0.0845 = 8.45 % p.a. This annualization is called the CAGR (Compound Annual Growth Rate).
What’s a “good” ROI?
Depends entirely on asset class, time horizon, and risk. Stock ETFs deliver 6–8 % real p.a. long-term, bonds 0–2 %, real estate 3–5 %. Translated to total ROI over the holding period — a 50 % ROI over 5 years is good for ETFs (≈8.5 % p.a.), weak for crypto speculation (risk much higher).
How do I account for inflation?
Real return = nominal return − inflation rate (rough). Cleaner for multi-year periods: (1 + nominal) / (1 + inflation) − 1. Example: 6 % nominal at 3 % inflation = 2.9 % real. Our Real-Return Calculator handles this automatically.
What’s a good ROI for marketing/ads?
Online marketing typically uses ROAS (Return on Ad Spend) — revenue / ad spend. A 4× ROAS means $1 of ads = $4 of revenue. ROI is different — it nets out cost of goods, shipping, returns. Healthy e-commerce ROI ranges typically run 30–60 % depending on margins.
Compute real return, simulate plans, factor in inflation
Headline ROI is rarely the full story. These tools surface the real numbers:
- Real-Return Calculator — nominal vs real, with inflation and tax
- DCA Simulator — multi-decade recurring-buy returns
- Correlation Matrix — risk profile of multi-asset strategies
- Tax Calculator — after-tax outcomes