What is ROI and how to use it

Return on investment compares what you gained with what you put in: (final value − initial investment) ÷ initial investment × 100. Turning 1,000 into 1,250 is a 25% ROI.

A negative result means a loss. Turning 1,000 into 800 is a −20% ROI.

ROI ignores how long it took. A 25% return in one year is much better than 25% over five years. To compare investments of different lengths, convert to an annual rate: (final ÷ initial)^(1 ÷ years) − 1.

A 25% ROI over 2 years is about 11.8% a year, because 1.25 to the power of one half is 1.118.

Include fees, taxes, maintenance and your own time in the investment, and use the value you would really receive after selling costs as the final value. Leaving costs out flatters the result.

For a business project, include the cost of the money tied up, since that capital could have earned a return elsewhere.

ROI says nothing about risk. A safe 5% and a speculative 5% look identical in the number. It also ignores the timing of cash flows when money comes in and out several times.

Use ROI as a quick first filter, then look at risk, time and cash flow before deciding.