When you're beginning investing, return on investment calculations (ROI) can help you avoid the worst decisions. What's more, they'll help you choose the best decision from the thousands of opportunities available.
The Beginning of Any Investing Career
Return on investment (ROI, in technical talk) is a simple measure to determine whether any investment is worth making. The mathematical formula for calculating ROI is as follows:
ROI = (gain - cost) / cost
- Say you want to invest £100 in tech company X. You figure that X will probably yield a 50% rate of return within a year, so the potential gain on your investment is £50. Plugging the numbers in (50 - 100) / 100, we get a result of -½, or -.5. The negative number here is what we want to watch out for. It's not an outright terrible situation - we're making £50, after all! -but it's not the best possible situation.
- We could, for example, invest £50 in tech company Y. Y yields a 100% rate of return, as best we can determine, so we'll make a potential gain of £50 again. (50 - 50) / 50 is zero - always a frightening number, but not a bad one in this case. Zero is higher than -.5, and so this is the better investment.
- Or, we could invest £25 in that arrogant upstart, company Z. Z promises results of 200% after they release their new software suite at the end of the year. You can do the math at this point: (50 - 25) / 25 gives us a solid 1, our highest number yet. The actual amount of money we're investing doesn't matter; our chances of seeing our money multiply does. If we invest £100 in company Z, we get back £200 - same initial outlay, much better result.
Seems like common sense, right? Most useful tools do. When you're beginning investing, ROI is an easy way to rate your options relative to one another and to put your money where it makes the most sense. In the world of investing, that's a wonderful thing to hope for.
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