ROI formula
ROI is the gain on an investment as a share of what it cost, so it answers "how much did I make for every dollar I put in?"
FINRA uses the same annualizing formula, (1 + return)1/years − 1,[1] which is the geometric average growth rate used in finance textbooks.[2] Example: $65,000 + $3,000 − $50,000 = $18,000 of profit, and $18,000 ÷ $50,000 = 36%. Because it took three years, the annual rate is (1.36)1/3 − 1 = 10.8%.
Why you should annualize ROI
A total ROI says nothing about time, so the same 36% is a very different result over one year or ten. Annualizing converts it into a yearly rate you can compare with other investments.
| Same profit, held for | Total ROI | Annualized ROI |
|---|---|---|
| 1 year | 36% | 36.0% |
| 2 years | 36% | 16.6% |
| 5 years | 36% | 6.3% |
| 10 years | 36% | 3.1% |
Annualized ROI assumes a single amount in and a single amount out. When money goes in and comes out at several times, as with rent each year, the internal rate of return (IRR) is the better measure; it can be computed on a property's cash flows and resale proceeds.[3] The investment property calculator does that for a rental.
ROI on a rental property
For a rental, ROI should count every source of return and every cost.
- Invested: down payment, closing costs and repairs before renting, not the full price, if you used a loan.
- Income: the cash flow after the mortgage for each year you owned it.
- At the end: sale price minus selling costs and the loan payoff.
| Measure | What it divides | Time |
|---|---|---|
| ROI (this page) | Total profit ÷ total invested | Whole period, or annualized |
| Cash-on-cash | One year of cash flow ÷ cash invested | One year |
| Cap rate | One year of NOI ÷ price | One year, no loan |
| IRR | All dated cash flows, discounted | Whole period, timing-weighted |
Common ROI mistakes
- Ignoring time. A 40% ROI over eight years is about 4.3% a year.
- Leaving out costs. Commissions, closing costs, repairs and taxes all reduce the return.
- Using the price instead of your cash. With a loan, divide by the cash you put in, and count the loan payoff at the end.
- Treating a past ROI as a forecast. Past performance does not necessarily predict future results,[5] and all investments involve some risk.[4]
For flips and exchangesThe house flipping calculator works out ROI on a renovation project, including financing and selling costs.
Frequently asked questions
How do you calculate ROI?
Subtract the total amount invested from the final value plus any income received, then divide by the total invested. $18,000 of profit on $50,000 is a 36% ROI.
How do you calculate annualized ROI?
Add 1 to the total ROI, raise it to the power of 1 divided by the number of years, and subtract 1. A 36% ROI over three years is 1.36^(1/3) − 1 = 10.8% a year.
What is a good ROI?
There is no single figure. Compare the annualized ROI with what a low-risk alternative pays over the same period, and with the risk and work involved.
What is the difference between ROI and IRR?
ROI compares total profit with the amount invested. IRR is an annual rate that accounts for when each cash flow happens, so it handles investments with income every year.