What is Rate of Return (RoR) and How Do You Calculate Investment Returns?

What is Rate of Return (RoR) and How to Calculate Investment Returns?

The RoR is one of the most effective ways to evaluate the efficiency and profitability of an investment. Investors can also use the RoR to compare assets and determine where they are playing their cards right.

Let’s say there are two traders. Each invests $1000. One puts the money into stocks and ends up with $1300 after a year. The other jumps into crypto and cashes out with $1500 after two years. Who made the better investment?

It may seem at first glance that the crypto investor did better, as they made more money. But there’s more to the story. To really compare investments, you need to look at how much each one returned and over what period.

This is where the rate of return, or RoR, can come in handy. It’s a simple but powerful way to measure how well your investment performed, no matter the asset, the risk level, or the timeframe.

What is the rate of return?

The rate of return (RoR) is a metric or a measurement that shows how much money you made or lost on an investment over a certain period. It is shown as a percentage of what you originally put in.

If your RoR is a positive number, you’ve made a profit. If it’s negative, you’ve taken a loss. No matter what you invest in - be it stocks, bonds, crypto, gold, real estate, or art - you’ll always have a rate of return. It helps you see if your money is working for you.

The RoR is easy to calculate, and the sheer amount of information investors and businesses can gather from it is the main reason why RoR is so relied upon. Its calculations come with many benefits, but they also have some limitations that you should be aware of.

Key components of the RoR

Net profit - the amount remaining after all expenses are deducted.

Investment cost - everything spent on developing your business.

The RoR formulais calculated as follows:(Current Value - Initial Cost / Initial Cost) x 100

Any gains made during the holding period of the investment must be included in the formula. For example, if a share costs $10 and its current price is $15 with a dividend of $1 paid during the period, the dividend should be included in the ROR formula. In this case, it would be calculated like this:

(($15 + $1 – $10) / $10) x 100 = 60%

Example of a rate of return (RoR)

Let’s say you bought a classic car that you plan to resell.

You bought it for $10 000 and paid in full. A few years later, you sold it for $13 000 after all costs like repairs or listing fees.

To calculate the rate of return:

($13 000 − $10 000) ÷ $10 000 × 100 = 30%

Your RoR is 30%, which means you earned 30% more than you originally spent.

Now let’s flip the situation.

Say the market didn’t go your way, and you ended up selling the car for only $7500.

The calculation would then be:

($7500 − $10 000) ÷ $10 000 × 100 = -25%

In this case, you would have lost 25% of your initial investment.

Example of an RoR with stocks:

The way we calculate rate of return (RoR) for stocks is pretty much the same, except that dividends are also factored in.

Let’s say you bought Coca-Cola Company (KO) stock for $60 and kept it for 5 years.Over the course of this time, you got $10 in dividends. Then, you sold the stock for $80. That means you made $20 by selling ($80 − $60) plus $10 in dividends, so your total gain is $30.

To find your RoR:$30 ÷ $60 = 0.50, or 50%

FAQ

How do investors use the RoR to inform their trades?

Investors often look at past RoR to compare similar investments and see which ones did better.

What is a risk management technique investors use the RoR for?

Many investors also like to set a required rate of return (RRR). It helps traders and investors choose the return they want before making a move.

What is considered a good RoR?

A return of around 7% per year is usually seen as good. That’s close to the long-term average yearly return of the S&P 500, after adjusting for inflation.

How does the RoR benefit traders in the long run?

It helps you plan. It's easier to decide where to put your money next when you know how much return you're going to get.

Share with friends:

Open an FBS account

By registering, you accept FBS Customer Agreement conditions and FBS Privacy Policy and assume all risks inherent with trading operations on the world financial markets.