Recently, a friend asked me how to calculate ROI, and I realized that many people are still quite unfamiliar with the concept of return on investment. Actually, ROI (return on investment) is the investment return rate—it’s used to measure how much profit your money can generate, and it’s a very practical financial indicator.

So how do you calculate ROI? The formula is net profit divided by total invested capital. For example, if you spend 1 million to buy stocks and receive 1.3 million when you sell, then ROI is (1.3 million - 1 million) / 1 million = 30%. But in real life, things are much more complicated—you need to account for all costs and all income.

Taking stock investment as an example, suppose you buy 1,000 shares at $10 per share. After one year, you sell at $12.5 per share and also receive $500 in dividends, with a trading commission of $125. In this case, total income is 12.5 × 1,000 + 500 = $13,000, total cost is 10 × 1,000 + 125 = $10,125, net profit is $2,875, so ROI = 2,875 / 10,000 = 28.75%.

When many people in e-commerce or the advertising industry hear how to calculate ROI, they actually mean a different concept called ROAS. ROI measures profit, while ROAS measures revenue. For example, if the cost of a product is $100 and the selling price is $300, and you sell 10 units through advertising with an ad spend of $500. If you calculate ROI: 【300 × 10 - (100 × 10 + 500)】 / (100 × 10 + 500) = 100%, but ROAS is (300 × 10) / 500 = 600%. The difference between the two is still quite significant.

There’s also an upgraded version called annualized investment return, which takes the time factor into account. The formula is 【(total return rate + 1)^(1 / number of years) - 1】 × 100%. For example, in Plan A, you earn 100% in 2 years; in Plan B, you earn 200% in 4 years. At first glance, B seems to make more money, but when annualized, A is 41.4% and B is 31.6%, so A is actually the better deal.

How do you improve the numbers after calculating ROI? There are basically two approaches: either increase profits or reduce costs. In stock investing, you can choose stocks with higher dividends, find brokers with lower fees, and reduce the number of trades. But honestly, these optimizations have limited impact. The most direct way is still to choose investment products that have a high ROI to begin with. Generally speaking, ROI is highest for cryptocurrencies and forex, followed by stocks, then index funds, with bonds being the lowest.

However, you should note that high ROI often comes with high risk. I’ve seen plenty of people focus only on the ROI number and end up getting trapped. So when choosing high-ROI investment products, you also need to look at other indicators such as volatility and valuation. For instance, if there are two stocks—one has volatility of 7 and the other has volatility of 3—you can adjust your position sizing to balance risk and return.

One more limitation of ROI is worth mentioning. First, it doesn’t consider time factors. Project X has an ROI of 25% and takes 5 years, while Project Y has an ROI of 15% but takes only 1 year—so Y is actually more efficient. Second, high ROI may imply high risk. If you focus only on the number and don’t consider risk, you may end up losing money. Third, costs are easy to miss. For example, in real estate investment, you need to account for loan interest, taxes, insurance, maintenance, and so on. If you overlook these, your ROI can be overstated.

Overall, understanding how to calculate ROI is just the foundation. The key in real investing is learning how to evaluate everything comprehensively. Don’t be misled by high ROI numbers—take risks, time, and costs into account.