If you’re new to the world of investing, then a return on investment (ROI) calculator can be a helpful tool to use along your journey. ROI is a ratio that represents the difference between the amount of money you initially invested in a certain financial product and the amount of money it’s earned you. It’s a key way to determine how profitable that investment has been for you over time.
To simplify the process of figuring out this ratio, you can use an ROI calculator. This tool can help you figure out exactly how well a given investment has performed over time. Let’s delve into what exactly an ROI calculator does and how to use one before you get started.
What Is a Basic ROI Calculator?
Before we get into how to use a basic ROI calculator, it’s important to understand the information it can provide. As mentioned, ROI involves a formula that determines the profitability of a certain investment. It works by calculating a percentage that reflects how much your original investment has grown.
Say, for instance, that you invested $100 in a stock. At the end of the year, you found that your investment had grown to $120. Your ROI in this case would be 20%.
If an investment performs poorly, your ROI can also turn out to be negative. Imagine that the same $100 investment had dropped in value and was now only worth $80. In this case, your ROI would be -20%, meaning you lost money on the investment.
Why Use a Basic ROI Calculator?
As you can imagine, being able to calculate the return on an investment is an important part of ensuring your money is working for you instead of against you. While every investor has their own set of guidelines, some prefer to cut their losses if an investment dips below a certain value. Legendary investor William O’Neil, for instance, advised selling any stock that generates a negative ROI of between -7% and -8%.
Not only can this keep you from incurring greater losses, but it can also help cut opportunity costs. Opportunity costs are the money you miss out on by keeping your money in a losing investment when there are better alternatives available.
Understanding ROI can also help you determine your exit plan on an investment by allowing you to set goals. Some investors cash out an investment when it yields an ROI of 20% or 25%. But again, this depends on the investment and your individual investing style.
How Does an ROI Calculator Work?
An effective basic ROI calculator requires very little information and is easy to use. Technically speaking, there’s a variety of different ROI calculators available, some of which use much more complex formulas than others.
Some calculators factor in all kinds of different information, from dividends to inflation rates. A business might even use an advanced ROI calculator to project forecasts of how an investment is likely to perform in the future.
However, if you’re looking for a simple way to gauge how an investment is doing, a calculator that uses this simple ROI formula should do just fine.
- ROI = (Net profit/Initial Investment) x 100
Net profit simply refers to the difference between the initial amount of money you invested and the amount you have now.
What Information Do You Need to Use a Basic ROI Calculator?
As you can see, it’s fairly easy to create a basic ROI template as long as you have the following information about an investment:
- How much money you invested
- How much money you have now
That’s all a good ROI calculator requires to churn out a basic ROI in seconds. Let’s look at an example to illustrate what we mean.
Say that you initially invested $100 to buy a share of a stock. One year later, your investment has grown to $150.
In order to calculate your ROI, an ROI calculator subtracts your original investment from the amount it’s worth now: $150-100 = $50. This reveals that your net profit on this investment is currently $50.
The calculator then divides your net profit by your initial investment: $50/$100 = 0.5. Last but not least, it multiplies 0.5 x 100 to reveal a 50% ROI.
Annualized Returns vs. ROIs
While the example above was pretty straightforward, when it comes to longer-term investments, you may also want to break down your annualized rate of return. This can be helpful for determining the average ROI your investment is earning in a given year.
While it might be tempting to simply divide your ROI by the number of years your money has been invested, calculating an annualized rate of return is a bit more complicated. This is especially true for investments like certificates of deposit (CDs), bonds and mutual funds, all of which rely on the concept of compounding. Simply put, compounding involves earning interest, which grows your initial investment. In turn, the investment earns even more interest on the interest it already earned.
For example, say you deposited $100 at a 5% annual interest rate. At the end of the first year, you’d have earned $5 for a new total of $105. At the end of the second year, you’d earn 5% on $105 for a return of $5.25, giving you a new total of $110.25.
Calculating Annualized Returns With an ROI Calculator
Due to the extra considerations of calculating annualized returns, the formula is a bit more complicated.
- Annualized Return = (1 + Return) ^ (1 / N) – 1
N= The number of periods you’re measuring.
Luckily, many basic ROI calculators make it easy to sidestep the math. Assuming you’re earning money at a set interest rate, all you have to do is enter your starting investment amount, the investment’s current value and the length of time your money has been invested. The calculator processes its equations and shows you your average yearly rate of return.
Knowing your way around a basic ROI calculator can come in handy for a variety of different investments. Whether you want to see how well your stock investments are doing or calculate prospective returns on a high-yield checking account, an ROI calculator is a convenient tool to have access to.
