Here's how to calculate investment returns (known as return on investment, or ROI for short) to see your portfolio's performance.
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Introduction – Return on Investment
Return on Investment (ROI) measures the gain or loss of an investment, as a percentage, relative to its cost. ROI is used in business to evaluate revenue performance, such as the return from marketing efforts. In the context of investing, we're talking about the investment returns of an asset or, more likely, of the portfolio as a whole.
The metric has a few shortcomings and a corollary that we'll explore further down.
How To Calculate Return on Investment – Formulas
The calculation for return on investment is very simple. It's just the ratio of the change in value to the original value. If we use CV to mean the current value of the investment and OV to mean the investment's original value, we can calculate the investment return, expressed as a percentage, using the following formula:
(CV ➖ OV) ➗ OV ✖️ 100 = ROI
We can simplify this somewhat to:
CV ➗ OV ➖ 1 ✖️ 100 = ROI
To calculate your return for a single year, for example, use the portfolio value on January 1 as OV and the value on December 31 as CV.
Here's an example. Let's assume you bought 100 shares of ABC at $10/share for a total cost basis of $1,000. The share price of ABC has since increased to $12.50 per share for a total value of $1,250 for your 100 shares. We can calculate the investment return like this:
$1,250 ➗ $1,000 ➖ 1 ✖️ 100 = 25%
So your ROI was 25%. This is usually simply called the “return.” If this number is positive, you gained money. If it's negative, you lost money.
How To Calculate Annualized Return aka Compound Annual Growth Rate (CAGR)
There's a glaring problem with ROI. ROI doesn't factor in the time period that the investment is held. Investors are likely more interested in annualized return, a measurement of the annual rate of return required for the investment to grow to its final value over a number of years. This is also called the compound annual growth rate, or CAGR for short. Here's the formula for CAGR using our variables above:
CAGR = (CV ➗ OV)1/n ➖ 1
where n is the number of years the investment is held. Suppose in our example above that you held ABC for 2 years:
CAGR = ($1,250 ➗ $1,000)1/2 ➖ 1 = 11.8%
If you've already calculated your ROI, you can also just use that in the calculation for annualized return:
CAGR = [(1 + ROI)1/n ➖ 1] ✖️ 100
[(1 + .25)1/2 ➖ 1] ✖️ 100 = 11.8%
Unlike pure ROI, CAGR does allow us to compare different investments, because it factors in the amount of time the investment is held.
How To Calculate CAGR in Excel and Google Sheets
There's no direct CAGR function in Excel or Google Sheets, but we can use the RRI function as follows to measure CAGR:
RRI(number_of_periods, present_value, future_value)
The arguments are:
number_of_periods: number of years the investment is held.
present_value: the initial value of the investment.
future_value: the final value of the investment.
Using our example from earlier would look like this:
CAGR vs. Average Annual Return
While the wording may be confusing, note that CAGR should always be preferred over average annual return, which is simply the mean value of returns over a certain time period. Brokers and advisors like to use the latter because it usually looks more impressive. In short, the average return is not the actual return. An example will make this distinction more clear.
Suppose an investment of $5,000 grows by 100% in the first year to $10,000 and then drops by 50% the next year back down to $5,000. Over the 2 years, your CAGR was zero; you have neither gained nor lost money. But your average annual return was 25%. Obviously this is very misleading.
So always ask your advisor what your CAGR was; tell them you're not interested in your average annual return.
Shortcomings of the Return on Investment (ROI) Metric
ROI has a few shortcomings as a standalone metric.
First, as we saw, it doesn't take into account the amount of time the investment is held. Comparing an Investment A with a 10% return to Investment B with a 20% return isn't an apples-to-apples comparison, as Investment A may have yielded that return in one year while Investment B took 10 years. We can solve this using annualized ROI aka CAGR.
Secondly, neither ROI nor CAGR per se tells us anything about the risk of the investment(s). In the example above in which Investment A returned 10% and Investment B returned 20%, Investment B may have been much riskier and could have been outside the risk tolerance of the investor.
Disclaimer: While I love diving into investing-related data and playing around with backtests, this is not financial advice, investing advice, or tax advice. The information on this website is for informational, educational, and entertainment purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. I always attempt to ensure the accuracy of information presented but that accuracy cannot be guaranteed. Do your own due diligence. I mention M1 Finance a lot around here. M1 does not provide investment advice, and this is not an offer or solicitation of an offer, or advice to buy or sell any security, and you are encouraged to consult your personal investment, legal, and tax advisors. All examples above are hypothetical, do not reflect any specific investments, are for informational purposes only, and should not be considered an offer to buy or sell any products. All investing involves risk, including the risk of losing the money you invest. Past performance does not guarantee future results. Opinions are my own and do not represent those of other parties mentioned. Read my lengthier disclaimer here.
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