Simple ROI vs annualized ROI
Simple ROI = (final value − cost) ÷ cost. It's the total percentage gain over the whole holding period, ignoring how long that took. A 60% ROI sounds great — but 60% over one year and 60% over ten years are wildly different investments.
Annualized ROI fixes this by converting the total return into a per-year rate using compounding: (final ÷ cost)1/years − 1. That 60% total becomes 60%/year over one year, but only about 4.8%/year over ten. Always compare investments on the annualized figure.
What to include in "cost"
Real ROI counts every dollar the investment required, not just the sticker price: purchase cost, fees, commissions, renovation or setup costs, and ongoing expenses. Leaving these out inflates ROI and is the most common way people fool themselves about a deal's quality.
Where ROI is used — and its blind spots
- Business projects: "this $5,000 software will save $8,000" is a 60% ROI decision.
- Marketing: revenue generated per dollar of ad spend.
- Investments: though for cash-flowing assets, annualized ROI (or IRR) beats simple ROI.
ROI's blind spot is risk and time. It says nothing about how likely the return was, or the volatility along the way. A 40% ROI from a government bond and a 40% ROI from a lottery-like startup are not equivalent, even though the number is identical. Use ROI to rank comparable options, not to justify taking on wildly different risks.