ROI Calculator

What return on investment measures

Return on investment answers one question: for every dollar you put in, how many dollars came back, and how much of that was profit? It is a ratio, not a dollar amount, which is why a $400 gain on a $1,000 investment and a $4,000 gain on a $10,000 investment both score 40 percent.

The measure is old and plain enough that the SEC keeps it in the Investor.gov glossary of investing terms. The version on this page is the cash version: money in, money out, plus any income the asset paid while you held it.

Three details decide whether the number is honest. First, the money in has to include every cost of getting in, such as commissions, closing costs and inspection fees. Second, the money out has to be net of the cost of getting out, such as selling commissions and transfer taxes. Third, any income received along the way counts, or a rental property will look worse than it is.

Get those three right and the formula is one line: ROI = (net proceeds + income - total cost) / total cost.

The formula, step by step

Work through a stock position. You buy shares for $4,000 including the commission, collect $120 in dividends over two and a half years, and sell for $5,200. There are no selling costs in this example.

The 33 percent is the total return over the whole holding period. The 12.08 percent is what steady yearly compounding would produce the same result, and it is the number to use when you compare this trade with anything else.

If a commission of $35 had been charged on the sale, the net proceeds would be $5,165, the profit $1,165, and the ROI 29.13 percent. Small fees move a small position a long way.

Worked example: a rental property with income

Property is where people most often get ROI wrong, because there are costs on both ends and income in the middle. Say you pay $250,000 for a house, spend $7,500 on closing costs, collect $13,800 a year in net rent for four years, and sell for $320,000 with a 6 percent selling cost.

The money in is $257,500. The sale nets 320,000 x 0.94 = $300,800, and the rent adds $55,200, so the money out is $356,000. Profit is 356,000 - 257,500 = $98,500, which is an ROI of 38.25 percent over four years.

That works out to 8.43 percent a year compounded, and 22.84 percent after 3 percent inflation. Notice how far the annual figure sits from the headline 38 percent: the headline covers four years, the annual figure covers one.

The rent number matters. Had the property sat empty for six months and collected only $48,300, the profit would fall to $91,600, an ROI of 35.57 percent, and the annualized return to 7.91 percent. A vacancy is a return problem, not just a cash flow problem.

This page does not deduct income tax. The IRS explains in Publication 550 how gains and losses are treated for tax purposes, and depreciation recapture can change the after-tax answer for a rental.

Why plain ROI needs a clock

ROI has no time in it. That is its strength, because it lets you compare a stock with a bakery, and its weakness, because 50 percent over one year and 50 percent over ten years are not the same achievement.

The fix is to annualize: take 1 plus the ROI, raise it to the power of 1 divided by the number of years, and subtract 1. A 50 percent total return becomes 50.00 percent a year over one year, 22.47 percent over two, and 4.14 percent over ten.

Annualizing assumes a smooth ride, which no investment delivers. A fund that returns 50 percent in ten years by gaining 8 percent a year for nine years and then jumping 20 percent in the last year has the same annualized figure as one that plodded along, and a different risk story.

For anything with cash flows in and out, such as a rental with repairs or a business with reinvestment, the internal rate of return is the better measure. Annualized ROI is the quick version for a single lump in and a single lump out.

ROI after inflation

A 33 percent gain over two and a half years sounds better than it feels once prices rise. The real return divides the multiple by the cumulative inflation over the same period.

With 3 percent inflation, prices rise by a factor of 1.03 raised to the number of years. Over two and a half years the multiple of 1.33 buys what 1.33 / 1.0767 = 1.2353 bought at the start, so the real return is 23.53 percent rather than 33 percent.

The Consumer Price Index from the Bureau of Labor Statistics is the usual gauge for that inflation rate. Use the change over your own holding period if you want the number to line up with your experience, and use a long-run average if you are projecting forward.

Long holding periods are where inflation does its damage. Over ten years at 3 percent, prices rise 34 percent, so a 50 percent nominal gain shrinks to 11.61 percent of real buying power.

ROI on a business or an ad campaign

The same formula prices a marketing campaign. Spend $2,500 on ads that produce $9,000 in sales, and the profit is $6,500, which is an ROI of 260 percent, or 3.6 times the spend.

Two cautions apply. The first is gross margin. If those sales carried $4,500 of product cost, the profit is $2,000 and the ROI is 80 percent, not 260. Advertising ROI should use contribution margin, not revenue.

The second is that a campaign's return arrives over weeks while the spend leaves in days. A 260 percent ROI measured over one month annualizes to a number so large it stops being useful, which is why marketers usually report payback period instead.

Businesses also quote return on invested capital, which divides operating profit by the capital tied up in the business rather than by the cash spent on one project. The two numbers answer different questions and should not be compared directly.

What ROI leaves out

Four things sit outside the formula, and each one can flip a decision.

Taxes. A 33 percent pre-tax return is not 33 percent in your pocket. The rate depends on holding period and on your bracket, so the calculator reports the pre-tax number and leaves the tax work to you and to Publication 550.

Risk. A 12 percent annualized return from a savings account and the same figure from a single stock are not equivalent. ROI has no term for the chance of losing the money.

Timing of cash flows. Money returned in year one can be reinvested; money returned in year ten cannot. Two projects with identical ROI can have different value for that reason alone.

Opportunity cost. A 6 percent return is a loss if the alternative was 8 percent. ROI describes one investment in isolation, so compare it against your next best option, not against zero.

Mistakes that make a return look better than it is

These five errors account for most of the inflated ROI numbers people quote.

Dividing profit by the sale price. A $1,320 profit on a $5,200 sale is 25.38 percent, but the money at risk was $4,000, so the ROI is 33 percent. The denominator is always the money you put in.

Leaving out the cost of getting out. A 6 percent selling cost on a $320,000 house is $19,200, which cuts the profit by a fifth in the rental example above.

Counting the whole sale as profit. The $5,200 is the return of capital plus the gain, not the gain. Subtract the cost first.

Mixing periods. A 20 percent return over three months annualizes to 107 percent, which is arithmetically right and practically meaningless.

Ignoring a loss. Buy at $12,000, sell at $9,600, and the ROI is -20 percent, which is minus $2,400 on the money in. With 2 percent inflation over three years the real loss is 24.61 percent. The calculator shows the negative sign; a spreadsheet with an absolute value in it will not.