Used across both the crypto market and traditional stock markets, return on investment (ROI) is a financial measure used to calculate an asset's growth and efficiency over a period of time. This useful measure has been used for decades to determine the success of one's investment.
In this article, we'll help you learn how to calculate the ROI on your investment so that you can implement it across your portfolio to determine your successes. Understanding your assets' ROI might lead to improved sales and revenue and solve a problem that many traders face time and time again.
Many businesses offering trading services might include a project ROI in their monthly or annual report to a customer, illustrating the successes of the site in black and white figures. However, be cautious when a company uses a set amount of return on investment statistics in their advertising, not even the top trading experts are able to predict with exact certainty the events, analytics and metrics that will take place in the future.
Bear with us as this gets slightly technical, it will all make sense in no time. This formula essentially revolves around determining the overall profit or loss one has made from a particular investment.
The formula used to determine ROI is ROI = (FVI - IVI) / IVI * 100%. In this formula, the FVI stands for the final value of an investment while IVI stands for the initial value of an investment.
Looking at a practical example, say you bought $1,000 worth of Bitcoin in January 2020 when it was trading for $8,807. Two years later you sell your Bitcoin in January 2022 when it was trading at $43,704 for $3,960.
In this scenario, the IVI is $1,000 while the FVI is $3,960. ROI = (FVI - IVI) / IVI * 100% translates to:
ROI = (3,960 - 1000) / 1000 * 100%
ROI = 296%
This equation is considered a base formula as it does not include additional factors like fees and expenses incurred when storing the asset. In order to establish the true ROI on your investment, you would need to determine what additional costs were incurred (transaction fees for example) and use the following formula:
ROI = (FVI - expenses - IVI) / IVI * 100%
One thing that ROI does not factor in is the risk associated with the asset. For example, higher ROIs typically come with higher risks while assets with lower ROIs typically hold a much lower risk in terms of gaining returns.
This holds true in the crypto market where new coins can suddenly soar in price creating a strong ROI for those that invested early. However, this ROI data will not be the same for an investor that enters the market at a later stage, and the risk will be much greater. Be wary of analysts using ROI statistics in digital marketing to make far-fetched conclusions about an asset's future success. Always use Google as a tool to verify the information, particularly for smaller coins.
Another limitation of this approach is that time is not taken into consideration. For instance, if your investment appreciates from $100 to $150, the ROI will always be 50% whether this happened over one year or ten years. This issue can be solved by using another formula, known as the annualized ROI.
This method illustrates the standardized annual rate of return on investment by considering the investment's tenure, providing insight into the money an investment product has yielded over a certain period of time. This formula will calculate the investment's average performance each year over the entire period.
The formula for annualized ROI is Annualized ROI = ((1 ROI) 1/n - 1) * 100%. Here, n represents the number of years of the investment.
Using the latter example above, your $100 growing to $150 will present an annualized ROI of 50% for one year while the ten year annualized ROI is 4.14%. A substantial difference, and one you wouldn't pick up on from using the standard ROI formula.
As the world's first cryptocurrency, Bitcoin has seen some incredible increases in price. Analysts often use the formulas outlined above for tracking the digital asset's short-term, medium-term, and longer-term ROI.
As of January 2022, these ROIs are calculated using the trading price of $43,834.36 (at the time of writing).
BTC Price: $33,922.96
ROI = (43,834.36 - 33,922.96) / 33,922.96 * 100%
ROI = 29.29%
BTC Price: $8,807
ROI = (43,834.36 - 8,807) / 8,807 * 100%
ROI = 3,977.21%
BTC Price: $818.41
ROI = (43,834.36 - 818.41) / 818.41 * 100%
ROI = 5,256.03%
These are wildly impressive results, particularly when compared to the traditional stock markets. Excuse us while we go question our personal ROIs for our crypto investments.