Recently, I’ve been studying investment returns and found that many people don’t really understand the basic concept of how ROI is calculated. I’ll share what I’ve put together.

ROI stands for return on investment. Simply put, it’s the money you earn divided by the principal you invested, expressed as a percentage. The formula is straightforward: (Income − Cost) / Cost × 100%. For example, if you spend $1,000,000 to buy stocks and sell them for $1,300,000, then ROI is (1,300,000 − 1,000,000) / 1,000,000 = 30%.

But in reality, calculating it isn’t that simple. Taking stock investment as an example, suppose you buy 1,000 shares at $10 per share. After one year, you sell them for $12.5 per share, and you also receive $500 in dividends, with trading commissions of $125. At this point, your total income is 12.5 × 1,000 + 500 = $13,000, your total cost is 10 × 1,000 + 125 = $10,125, and your net profit is $2,875. Finally, ROI = (2,875 / 10,000) × 100% = 28.75%.

People in the advertising industry also often talk about ROI, but what they actually mean isn’t true ROI—it’s ROAS (return on ad spend). ROAS = Revenue / Advertising Cost. The difference is that ROI measures profit, while ROAS measures revenue. Using the same example: a product costs $100 and sells for $300. You sell 10 units through advertising, and the ad spend is $500. The ROI formula is [(300 × 10 − (100 × 10 + 500)) / (100 × 10 + 500)] = 100%, while ROAS is (300 × 10) / 500 = 600%.

If you want to compare investments across different time periods, looking only at ROI can be misleading. In that case, you need to use the annualized return. For example, Plan A earns 100% over 2 years, and Plan B earns 200% over 4 years. At first glance, B seems like the better deal, but when annualized: A is [(1 + 1)^(1/2) − 1] × 100% = 41.4%, and B is [(2 + 1)^(1/4) − 1] × 100% = 31.6%. So actually, A is more worthwhile.

ROI can also be used to measure a company’s return on investment. Many people confuse ROI, ROA, and ROE. In simple terms: ROI = Net profit / Total investment, which looks at the return on invested capital. ROA = Net profit / Total assets, which looks at the return on all assets (including borrowed money). ROE = Net profit / Shareholders’ equity, which shows how much profit the shareholders’ money generates.

To improve the results of “how to calculate ROI,” there are basically two directions: increase profits or reduce costs. For example, with stock investments, you can choose dividend-paying stocks, find brokers with lower fees, and reduce the frequency of trading. But the room for optimization is actually limited. The most direct approach is to choose investment targets that inherently have high ROI. Generally, the ROI ranking is: cryptocurrencies and forex > stocks > index funds > bonds.

However, you should note that a high ROI often comes with high risk. Cryptocurrencies are highly volatile; forex is heavily influenced by international situations. Gold may preserve value, but its upside is limited. In relatively mature markets like the U.S. stock market, the average annual return is over 12%, with volatility that’s comparatively more manageable. When choosing what to invest in, you should consider metrics like volatility and valuation—you can’t just focus on the ROI number.

Even though ROI is useful, it has a few obvious pitfalls. First, it doesn’t account for the time factor. For example, Project X has an ROI of 25% but takes 5 years, while Project Y has an ROI of 15% but only takes 1 year. Clearly, Y is more worth it. That’s why when comparing investments, it’s best to look at annualized returns. Second, high ROI doesn’t mean low risk. Some investments deliver high returns but also have huge volatility—you might get stuck early on. Third, incomplete cost calculations can overstate ROI. For example, real estate investment should include mortgage interest, taxes, insurance, and maintenance costs; otherwise, the calculated return will be artificially inflated. Finally, ROI only looks at financial returns and ignores other benefits such as social impact or environmental value.

In summary, understanding how ROI is calculated is only the first step. More importantly, in real-world investing, you need to learn how to balance returns and risks, and choose suitable assets based on your risk tolerance and investment horizon.