Just like a seasoned sailor navigates through the vast sea using a compass, a savvy investor uses the return on investment (ROI) as a key compass in navigating the sea of financial decisions. But, what makes a good ROI? Understanding what constitutes a good ROI is crucial for making sound financial choices, whether that’s investing in stocks, bonds or real estate. That strong ROI is going to vary by investment and time period. You may want to work with a financial advisor for the best potential ROI on your portfolio investments.
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What Is Return on Investment (ROI)?
ROI is a performance measure used to evaluate the efficiency or profitability of an investment. The higher the ROI, the better the investment is perceived to be performing. If we compare investing to sailing again, consider ROI as the direction of wind – the stronger it blows, the faster it helps you reach your destination. Essentially, the ROI in your investment is going to be the amount of money you’re able to make from your initial investment and a number of factors are going to impact that return.
In the context of investments, ROI serves as a universal barometer of profitability. It allows investors to compare the efficiency of different investments and make informed decisions based on data rather than solely on intuition or speculation. This is where professional financial advisors can play a key role in helping investors evaluate different investments, increasing the accuracy of ROI calculations. So whether it’s comparing different stocks or analyzing the profitability of real estate investments, ROI, along with professional advice, is a critical factor in any investment decision-making process.
ROI can be used in various ways to evaluate investment opportunities. It can help in deciding which stocks to buy, whether to invest in real estate or not and even whether a particular business venture is worth pursuing. Appreciating ROI helps investors to make educated decisions on where to deposit their money to work most effectively. Calculating what your potential ROI could be can help you effectively find the right investments for your portfolio.
How to Calculate ROI
Calculating ROI is actually quite straightforward. You start by subtracting the cost of the investment from the current value of the investment. Then, divide the result by the cost of the investment. Finally, multiply the result by 100 to get a percentage. For instance, if you bought a stock for $100 and sold it for $120, your ROI would be 20%.
Consider another scenario related to long-term investment or real estate. If you bought a house 10 years ago for $200,000, which is now worth $260,000, your ROI, not considering other costs, would be 30%. While it might be easy to calculate, it’s not easy to determine what makes a good ROI.
What Is Considered a Good ROI for Investing?
A “good” ROI can vary significantly depending on the type of investment and individual circumstances. Financial advisors can help clarify this by considering individuals’ risk tolerance, age, income and other factors. However, here are some general guidelines:
- General ROI: A positive ROI is generally considered good, with a normal ROI of 5-7% often seen as a reasonable expectation. However, a strong general ROI is something greater than 10%.
- Return on Stocks: On average, a ROI of 7% after inflation is often considered good, based on the historical returns of the market.
- Return on Bonds: For bonds, a good ROI is typically around 4-6%.
- Return on Gold: For gold investments, a ROI of more than 5% is seen as favorable.
- Return on Real Estate: A good ROI for real estate investments is typically around 10% or more.
- Return on Alternative Investments (cryptocurrencies, peer-to-peer lending, etc.): The ROI can vary significantly, but a double-digit ROI is often considered good.
Ultimately, what really matters in your ROI is having a return that helps you reach your short- or long-term goals.
Keep in mind that ROI doesn’t account for the time value of money, risk or cash flows, which can all significantly impact an investment’s profitability. This doesn’t give you a full picture of how an investment is working for you.
Bottom Line
ROI is a potent tool for making informed investment decisions. By understanding how to calculate and apply ROI, investors can make decisions that empower them on their financial journey. However, it’s crucial to remember that ROI doesn’t guarantee a cargo full of treasures. It’s a component of the puzzle and should be used along with other measures to evaluate the overall performance and suitability of an investment. It guides you in the wide ocean of investments, but remember, a good sailor always uses more than one navigational tool.
Tips for Investing
- When investing you’ll likely want to maximize your potential returns, which can be difficult to do if you don’t have expertise. That’s where a financial advisor comes in. They can help you make an investing plan and help you find the right asset mix to reach your goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- You can also use SmartAsset’s free investment calculator to help you see what your portfolio could return based on your asset mix.
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