Master the ROI calculation formula and make investment returns your decision-making weapon

Why Must Investors Understand the ROI Calculation Formula?

Return on Investment (ROI) is a core financial metric used to measure investment efficiency, expressed as a percentage representing the return relative to the initial investment. Whether you’re managing personal finances, evaluating a company’s profitability, or analyzing advertising effectiveness, ROI is an indispensable key indicator. Understanding the logic behind the ROI calculation formula can help you quickly determine whether an investment decision is reasonable.

What Is the Essence of the ROI Calculation Formula?

ROI = (Investment Income - Investment Cost) / Investment Cost × 100%

The core of this formula lies in: profit divided by initial investment. Simple and straightforward, but in practical application, the definition of “cost” and “income” often determines the accuracy of the calculation.

For example, in stock investing, suppose you buy a stock for 100,000 yuan, sell it after a year for 130,000 yuan, and receive 5,000 yuan in dividends, but pay 1,250 yuan in transaction commissions. Then:

• Total income = 130,000 + 5,000 = 135,000 yuan
• Total cost = 100,000 + 1,250 = 101,250 yuan
• Net profit/loss = 135,000 - 101,250 = 33,750 yuan
• ROI = 33,750 / 100,000 × 100% = 33.75%

ROI Calculation Logic Differs Across Fields

The ROI in e-commerce advertising is fundamentally different from ROAS

Many people confuse ROI and ROAS in e-commerce. Both are used to measure investment returns, but their calculation logic is entirely different:

ROI = (Sales Revenue - Total Cost) / Total Cost × 100%
ROAS (Return on Ad Spend) = Sales Revenue / Advertising Cost × 100%

The difference is: ROI considers profit margin, including product costs; ROAS only looks at revenue generated from advertising costs.

For example, with a product cost of 50 yuan, a selling price of 150 yuan, selling 100 units through advertising costing 5,000 yuan:

• ROI = (150×100 - 50×100 - 5000) / (50×100 + 5000) × 100% = 66.7%
• ROAS = (150×100) / 5000 × 100% = 300%

The same ad spend makes ROAS look more impressive, but ROI is the true indicator of profitability.

Annualized Investment Return: Eliminating Time Bias

Simple ROI ignores the length of the investment period, which can lead to misleading conclusions. The annualized investment return solves this problem:

Annualized Return(%) = [(Total Return Rate + 1)^(1/Investment Years) - 1] × 100%

Compare two investment schemes:

• Scheme A: 100% return over 2 years
• Scheme B: 200% return over 4 years

Calculating annualized return:

• Scheme A = [(1+1)^(1/2) - 1] × 100% = 41.4%
• Scheme B = [(2+1)^(1/4) - 1] × 100% = 31.6%

Although Scheme B has a higher total return, Scheme A’s annualized return is better.

ROI, ROA, ROE: The Triangle of Corporate Financial Analysis

All three metrics use “profit” as the numerator, but their denominators represent different investment perspectives:

Suppose a company has total assets of 1 million yuan (of which 500,000 yuan is shareholders’ equity and 500,000 yuan is debt), invests 100,000 yuan in a project, and earns 200,000 yuan after half a year:

• Project ROI = (20 - 10) / 10 = 100%
• Annualized ROA = 150 / 100 = 150%
• Annualized ROE = 150 / 50 = 300%

The same profit looks very different from different perspectives.

To Improve ROI, Focus on Two Approaches

The formula determines that there are only two ways to increase ROI:

1. Increase Profit
In stock investing, choosing high-dividend stocks can significantly boost returns; in trading, leverage can amplify gains (but also increases risk).

2. Reduce Costs
Opt for brokers with lower commissions, decrease trading frequency, or find undervalued investment targets—these are direct ways to cut costs.

ROI Rankings Across Different Investment Categories

Based on historical performance, the average ROI ranking of investment categories is roughly:

Cryptocurrencies & Forex > Stocks > Indexes & Funds > Bonds

But higher ROI comes with higher risk. For example, the US stock market has an average annual ROI of over 12% over nearly 200 years, but this is a long-term average after multiple crises. Meanwhile, short-term ROI in cryptocurrencies can double, but volatility may cause losses.

If you favor a high-ROI category but worry about risk, you can balance by adjusting your position size. For example, if volatility ratio is 7:3, you might reverse the allocation to 3:7.

Three Pitfalls When Using ROI

Pitfall 1: Ignoring Investment Period
A 25% return in one year does not equal a 25% return over five years; annualized return is needed for fair comparison.

Pitfall 2: Focusing Only on Returns, Ignoring Risks
A high ROI number is meaningless if volatility is high; investors might panic and sell at a loss during market downturns. Risk indicators like volatility and PE percentile should be considered together.

Pitfall 3: Incomplete Cost Calculation
In real estate, omitting mortgage interest, taxes, maintenance costs, etc., can severely overstate ROI. All expenses must be carefully itemized before calculating.

Besides ROI, What Else Should Be Considered?

Beyond financial returns, modern investors increasingly care about social and environmental benefits. The concept of “Social Return on Investment” (SROI) attempts to quantify non-financial gains, making investment decisions more comprehensive and balanced.

Summary: ROI is just the starting point for investment decisions, not the endpoint. Understanding the ROI calculation formula is only the first step. In practical application, it’s crucial to consider time, risk, costs, and other multidimensional factors to make smarter investment choices.