Finance📅 12 March 2025⏱ 5 min read
How to Calculate Return on Investment (ROI)
ROI is the simplest way to compare whether any investment was worthwhile — but the basic formula hides important nuances. Here's how to calculate it correctly and avoid the common traps.
JW
James WhitfieldPersonal Finance & Maths WriterJames has written about personal finance, health metrics, and everyday mathematics for over six years. He holds a BSc in Mathematics from the University of Leeds.
Return on Investment (ROI) is the most widely used performance metric in business and investing. Its simplicity is a strength — and a weakness, because that simplicity can obscure things that matter. Here's how to use it correctly.
The Basic Formula
ROI % = (Net Profit ÷ Cost of Investment) × 100
Net Profit = Final Value − Initial Cost
Example: Buy shares for £5,000, sell for £6,500
Net profit: £6,500 − £5,000 = £1,500
ROI: (£1,500 ÷ £5,000) × 100 = 30%
Including Income Returns
For investments that generate income (dividends, rent, interest), include income received in the net profit calculation:
Net Profit = (Final Value − Initial Cost) + Income received
Buy-to-let property: £150,000 purchase price
Sell after 5 years for £170,000
Rental income after costs: £3,000/year × 5 = £15,000
Net profit: (170,000 − 150,000) + 15,000 = £35,000
ROI: (35,000 ÷ 150,000) × 100 = 23.3% total over 5 years
Annualised ROI
Raw ROI ignores how long the investment was held. A 30% ROI over 10 years is much less impressive than 30% over 1 year. Annualised ROI (CAGR) allows fair comparison:
Annualised ROI = (1 + ROI/100)^(1/years) − 1
Example: £5,000 grows to £6,500 over 3 years
Raw ROI: 30%
Annualised: (1.30)^(1/3) − 1 = 1.0914 − 1 = 9.14%/year
Example: £5,000 grows to £6,500 over 8 years
Annualised: (1.30)^(1/8) − 1 = 1.0336 − 1 = 3.36%/year
Very different outcome from the same raw ROI.
ROI for Business Decisions
Marketing ROI:
ROI = (Revenue generated − Marketing cost) ÷ Marketing cost × 100
Spent £2,000 on advertising, generated £8,000 in sales:
Net: £8,000 − £2,000 = £6,000
ROI: £6,000 ÷ £2,000 × 100 = 300%
Training ROI:
Training cost: £1,500
Productivity gain (est.): £600/month = £7,200/year
ROI (year 1): (7,200 − 1,500) ÷ 1,500 × 100 = 380%
What ROI Doesn't Tell You
Time: Addressed with annualised ROI, but the basic formula ignores it completely.
Risk: A 15% ROI with near-zero risk (e.g. a fixed savings bond) is very different from 15% ROI from a startup investment. ROI doesn't capture the probability of loss.
Costs of capital: If you borrowed money to make the investment, the cost of borrowing must be deducted from the net profit.
Inflation: A 5% ROI during 4% inflation is a 1% real return. Real ROI = Nominal ROI − Inflation rate.
Real ROI vs Nominal ROI
Real ROI = ((1 + Nominal ROI) ÷ (1 + Inflation rate)) − 1
Example: 8% nominal return, 3% inflation
Real ROI = (1.08 ÷ 1.03) − 1 = 1.0485 − 1 = 4.85% real return
This is the return in terms of actual purchasing power gained.