Here's how to calculate investment returns (known as return on investment, or ROI for short) to see your portfolio's performance. We'll specifically look at ROI and CAGR in detail.
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Contents
Introduction – Return on Investment (ROI)
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.
ROI Calculator
How To Calculate Return on Investment (ROI) – 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.
ROI vs. CAGR
There's a glaring problem with ROI, though. 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.
Unlike pure ROI, CAGR does allow us to compare different investments, because it factors in the amount of time the investment is held.
Let's look at how to calculate CAGR.
How To Calculate Annualized Return aka Compound Annual Growth Rate (CAGR)
Here's the formula to calculate 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%
CAGR Calculator
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:
RRI(2,1000,1250)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.
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Hi. I’ve really struggled to decide what the most meaningful and useful way is to calculate my Investment returns. On a “per ETF” or “per stock” basis, it’s never as simple as OV CV over time because I’m usually building up positions over time and sometimes may take some profit or loss to reduce risk.
So most of my investments individually have histories of multiple buy and sells over different lengths of time periods. And ofc in between that there is market activity and sometimes dividends.
What would be the most accurate way to measure the performance of the investments themselves, within my given time period as well as measure my personal performance of when I added or reduced my position size?
I believe it’s using TWRR & MWRR but the nuance of cash flows and non-round time periods ( a year) seem to make it very complex- taking more time to calculate than I’ have to spend on it.
Also, it’s important to know your portfolio performance as a whole as well, which overall has cash flows, weights, and metrics of its own like its Sharpe Ratio, Beta and overall yield or financial ratios..
Not to mention things like geometric mean when looking at a per quarter report.
Do you have any suggestions for the most efficient and useful way to go about this and which methods give the most actionable results and which are not really worth the time?
This is my biggest struggle when it comes to figuring out how optimized my portfolio is for my goals and trying to do it without relying on my brokerage platform to tell me using methods that may look better than the actual performance.
Any tips?
Thanks