Want to invest and make money? First learn the meaning and calculation of ROI—master the core skills of investment return in this article

Why Are Investors Focusing on ROI?

Whether you’re a stock market beginner or a seasoned trader, you’ve probably heard the term: return on investment. This term has multiple roles in the financial world—it may refer to the percentage profit from your personal investments or to sales conversion efficiency in advertising. Many people have a vague understanding of what ROI means, which can lead to misleading investment decisions. Today, we’ll clarify this concept fundamentally and show how to use it to optimize your investment strategies.

What Does ROI Mean: The Core Definition of Return on Investment

Return on Investment (ROI) is a financial metric that measures the profitability of an investment, expressed as a percentage. Simply put, it answers the question: how much percentage of your invested money have you earned back?

ROI has a wide range of applications. In personal finance, it helps you determine whether an investment is worthwhile; in corporate decision-making, it compares the efficiency of different projects; in advertising, it measures whether marketing expenses generate the expected sales conversions.

ROI Calculation Formula

The calculation method is quite straightforward:

ROI (%) = (Net Profit ÷ Total Investment) × 100%

where Net Profit = Investment Income - Investment Cost

Let’s understand with an example. Suppose you buy a stock for 1 million yuan, and after one year, you sell it for 1.3 million yuan, then ROI = (130万 - 100万) ÷ 100万 = 30%. It looks simple, but real-world calculations are much more complex because income and costs often involve multiple components.

How to Calculate ROI for Stock Investments

Calculating ROI for stocks requires considering multiple factors. Suppose you buy 1,000 shares at $10 each, and after a year, sell at $12.5, receiving $500 in dividends, with total transaction fees of $125.

In this case:

• Total Income = (12.5 × 1000) + 500 = $13,000
• Total Cost = (10 × 1000) + 125 = $10,125
• Net Profit = 13,000 - 10,125 = $2,875
• ROI = (2,875 ÷ 10,000) × 100% = 28.75%

Note the key point here: all implicit costs, including transaction fees, taxes, etc., must be included; otherwise, ROI will be artificially inflated.

ROI Application in E-commerce and Advertising

In e-commerce and marketing, ROI follows different calculation logic. Suppose the production cost of a product is $100, selling price is $300, and you sell 10 units through advertising, with an ad spend of $500:

ROI = [300 × 10 - (100 × 10 + 500)] ÷ (100 × 10 + 500) = 100%

However, in practice, many marketing professionals refer to ROAS (Return on Ad Spend).

ROI and ROAS: Two Concepts That Are Easily Confused

ROAS is calculated as: ROAS = Revenue Generated by Ads ÷ Advertising Cost

The difference is:

• ROI measures profit, including all costs
• ROAS measures revenue, only considering advertising expenses

Using the same example: ROAS = (300 × 10) ÷ 500 = 600%

This looks much more impressive than an ROI of 100%, so many advertisers prefer to cite ROAS rather than ROI.

The Importance of Time: Annualized Return

A major limitation of ROI is that it ignores the time factor. Annualized ROI overcomes this:

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

Compare two scenarios:

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

Calculating annualized return:

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

Result: Scenario A has a higher annualized return and is the better choice.

ROI, ROA, ROE: The Three Major Indicators at the Corporate Level

For individual investors, ROI is key; for companies, three different metrics are used:

Suppose a company has assets of 1 million (50% debt, 50% equity), invests 100,000 in a project, and earns 200,000 in return:

• Project ROI = (20 - 10) ÷ 10 = 100%
• Annual profit = 1.5 million, ROA = 150 ÷ 100 = 150%
• ROE = 150 ÷ 50 = 300%

How to Improve Investment ROI

From the formula, increasing ROI involves two directions: increasing profits or reducing costs.

Specific approaches in stock investing:

• Choose high-dividend stocks
• Select brokers with low commissions
• Reduce unnecessary trading frequency

However, these micro-adjustments often have limited effects. The most effective way is to select investment assets with inherently higher ROI. Generally, the ranking of investment returns is:

Cryptocurrencies and Forex > Stocks > Index Funds and Mutual Funds > Bonds

Of course, higher ROI usually comes with higher risk. When choosing cryptocurrencies or stocks, if their volatility ratio is 7:3, you can adjust your position to 3:7 to balance risk and return. Also, pay attention to valuation metrics like PE percentile to select undervalued assets.

Comparison of High-ROI Investment Methods

CFD Contract Trading

CFD is an over-the-counter trading instrument known for low margin and flexible operations. The margin requirement for stock CFDs is 20%, meaning with $2,000 you can trade a position worth $10,000. If you profit $500, ROI can reach 25%, which is a considerable return.

Forex Margin Trading

The forex market is the largest financial market globally, with two-way trading, 24-hour operation, and sometimes yields over 30%. However, the risks are proportionally higher, requiring traders to have strong market sensitivity and risk management skills.

Gold Investment

Gold combines value preservation and appreciation functions and is an important hedging tool. In 2019, international gold prices increased by 18.4%, reaching an 8-year high. During economic volatility, gold usually performs steadily.

Stock Investment

The US stock market has an average annual return of over 12% over nearly 200 years, known for reasonable valuation and stable dividends. With continuous policy dividends, it is attractive for long-term investors.

Precautions When Using ROI

Although ROI is widely used, it has obvious limitations.

Time Dimension Issue: Project X has an ROI of 25%, and project Y has 15%, making X seem better. But if X takes 5 years to generate that ROI, and Y only 1 year, the conclusion is completely different. Therefore, annualized return should be used for comparison.

Risk-Return Tradeoff: High ROI often indicates high risk. Focusing only on ROI figures without considering volatility can lead to panic selling after the first year of losses.

Overlooked Hidden Costs: When calculating ROI for real estate, omitting mortgage interest, property taxes, insurance, maintenance costs, etc., can significantly overstate ROI. All expected costs should be included.

Underestimating Non-Financial Benefits: ROI emphasizes monetary gains and may ignore social benefits or environmental value, which can bias conclusions when evaluating certain projects.

Mastering the true meaning and calculation methods of ROI is fundamental for every investor. But don’t forget, the risks behind the numbers are equally important. Reasonable return expectations, thorough risk assessment, and scientific position sizing are the secrets to long-term stable investing.