How it’s calculated
ROI is the net gain divided by what was invested. Because a 50% gain over 3 years is not the same as 50% in one year, the annualized ROI converts it to the steady yearly rate that compounds to the same result (a geometric average).
Example: invest 10,000 and get back 15,000 after 3 years. ROI = 5,000 ÷ 10,000 = 50%. Annualized: 1.5^(1/3) − 1 = 14.47% per year, since 1.1447³ ≈ 1.5.
Simple ROI ignores the timing of cash flows in between, fees, taxes and inflation. It is a comparison tool, not investment advice.
Frequently asked questions
What is a good ROI?
It depends on the risk and the time taken. ROI only means something compared with a benchmark, such as your cost of capital or an alternative investment over the same period.
Why is annualized ROI lower than ROI ÷ years?
Because returns compound. 50% over 3 years is 16.67% a year in simple terms, but only 14.47% a year compounded, since each year’s gain also earns a return.
How do managers use ROI?
In managerial accounting, divisional ROI is operating income ÷ average invested assets, used to compare divisions or projects of different sizes.
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Sources
- Principles of Accounting, Volume 2, 12.3: Evaluate an Operating Segment or a Project Using Return on Investment, Residual Income, and Economic Value Added — OpenStax
- Principles of Finance, 15.1: Risk and Return to an Individual Asset (geometric average return) — OpenStax
Formulas are taken from the free public references above. Results are provided “as is” for informational and educational purposes only. See our disclaimer.
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