Return On Investment (ROI) or Return On Investment Capital (ROIC) is a financial formula for calculating the profitability of an investment.
This article will serve as a guide to making the best choice of investment in 2022 and how to calculate ROI.
Categories of Investment
- High-Interest Savings Account: it is one of the safest ways to invest your money because there is no volatility. High-Interest Savings Account offers 1.3% interest per year which is different from the typical savings account, which offers 0.136% interest. The vital thing here is security.
- Real Estate: as demand for homes continues to rise above the supply; Real Estate investment will thrive in this embattled economy.
Although this investment category has a high level of risk compared to other investments but remains a good place to invest your money for high returns on investment.
- Stocks: this is the most common type of investment. It is a means of acquiring a share or equity in a company. When you buy stocks, you become a shareholder and a decision-maker.
- Bonds: Government and corporations issue bonds. A bond is like a loan to an entity (Government or Corporations) by investors who buy them. The entity repays the loan (principal or purchase price) over an agreed period. Bonds are safer than stocks as they are fixed-income security. This means that the buyer is protected from loss in purchasing power due to inflation.
- Exchange-Traded Funds (ETFs): these are mutual funds but are a collection of investments that can be purchased and sold on stock markets. ETFs are not stable as there are fluctuations in the price throughout the trading day.
- Mutual Funds: as the name implies, it is a collection of the money of many investors, which is invested in different companies or many stocks. Mutual funds are managed by a Fund Manager who is paid for lending his expertise and efforts.
- Certificates of Deposit (CDs): this investment option is offered by banks. It involves an investor giving a certain amount of money for a set time agreed upon by the parties involved, usually 5 to 10 years. The return on invested capital for Certificates of Deposits is paid at the end of the agreed term.
- Options: this is an investment in which an investor places an order to buy or sell stocks at a given time at a certain price known as the strike price. The buyer is given an option and not an obligation to engage in the transaction. Options are divided into two categories; call options for buying stocks and put options for selling stocks. Options investors lose their investment capital when the stock depreciates from its initial price.
- Cryptocurrencies: this investment has recently taken over as an investment option for Gen Z and Millennials.
Cryptocurrency is simply an encrypted currency with a decentralized ledger system or regulatory body. Bitcoin being the most popular and most priced cryptocurrency has led to countless alternative coins (altcoins). Investment in cryptocurrencies are highly volatile, and many have learned the difficult way in this investment due to the wild fluctuations in their price.
Platforms like Luno, Coinbase, Finance and Robinhood have made it easy for people to invest in different coins, especially the popular Bitcoin.
- Commodities: as old as this category of investments may be, it remains one of the most indulged investments by different generations. A commodity is a physical product or natural resource you can invest in. This can be a metal (precious metal like gold and silver); agricultural produce (corn, wheat, palm oil and soybeans); Livestock (cattle); Energy (crude oil, petroleum products and natural gas).
Commodities are good investments, especially during inflation. An investor who desires to invest in commodities may purchase physical products or invest through stocks, ETFs and futures contracts.
How To Find Investments with Highest Returns
Gen Z and Millennials are quite financially educated, and they know how to use the money they have to make money by investing in different investment categories ranging from stocks, bonds to cryptocurrencies.
All investments are with a certain amount of risk. Many of the 18 – 40 age group have entered into investments without considering the safety of such investments and their returns to know if their choice is the best offer in the market.
We have experienced a rise in the cost of living since the Covid-19, which has made it necessary to invest where you can get the highest returns and with the lowest possible risk.
To find investments that guarantee the highest return on investment might be highly demanding. Here are some helpful tips to finding investments with the highest returns;
- Know the Investment Position in the Market
Before jumping to a conclusion about the investment to put your hard-earned money into, you should endeavor to know which investment category is trending in the market, be it stocks, bonds or cryptocurrencies.
Study the market because what worked last year may fail to yield the same or no results in 2022.
- Do Not Listen to False Claims
Most Gen Z and Millennials rely on friends for updates on stocks and trends in the market. This is often seen in cryptocurrency investments.
The naive ones would jump into investments without studying the markets themselves or listening to professionals in that field.
- Be Passionate About Learning
The investment markets are difficult to predict; it is only certain that they will be volatile. It certainly requires time to become a successful investor.
Although Gen Z and Millennials are not the patient type, the journey to successful investments is a gradual process. There will be mistakes but be willing to learn from them.
- Know What Works For You
According to the most successful investor ever, Warren Buffett, “Never invest in a business you cannot understand.” It would help if you manage your resources in a disciplined manner.
Your strategy, personality, and resources must guide your choice of investment. If you are not good at taking risks, do not opt-in for the short term returns type of investments.
Although you must learn to invest in more than one portfolio, you need to start your investment journey with a low-risk portfolio and long term plans.
- Do Not Put All Your Eggs In One Basket
There are many categories of investments, as we have earlier seen in this article. You may decide to put your money into one investment due to the promise to pay back a mouth-watering return on investment, this is not appropriate because the market constantly experiences fluctuations.
As an investor too to be successful, you must study these market fluctuations first to escape losses that you may never recover from.
How To Calculate Return On Investment (ROI)
Over the years, growing wealth has been the most crucial decision. After building that wealth and getting closer to your financial goal, bonds can help you sustain it.
To avoid losses, an investor must calculate the return on investment for a portfolio they intend to put their money into. Below are ways of calculating return on investment for any investment.
The basic ROI formula is:
ROI = Net Profit / Total Investment Capital x 100
To use the above formula, below are the steps to follow:
- Find the Net Profit
You bought a house, say $500,000. After one year, you sold the house for $580,000 and a profit of $80,000 due to high demand faced with low supply. Usually, the seller pays a commission to agents of both parties involved, say you paid 5% of the amount you sold the property or $29,000. When selling the house, you will use escrow to transfer the documents of the house and collect the money, which will cost you another 3% of your sales value, or $17,400. You will also pay 25% on the profit in the property value of $80,000 in capital gains tax which will cost you another $20,000. Other logistics may be taken care of during the purchase and sale of the property, which we will not go into to keep the example brief. Let’s see the calculation using the example provided:
Net Profit: ($580,000 – $500,000) – ($29,000 – $17,400 – $20,000)
= $80,000 – 66,400
You have succeeded in subtracting the purchase price from the property’s sales value; then, you deduct all other expenses incurred during the purchase and sales of the property. This includes any commission paid to the agents, escrow fees, and capital gains tax.
- Deduce the cost of investment
You purchased the house for $500,000 at the period through a conventional home loan at 20% down, or $100,000; then it means the cost of investment here would be $100,000
Cost of Investment = $100,000
- Determine the Percentage
This is the final step, and it is to divide your net return of investment of $13,600 from Step 1 by your cost of acquisition of $100,000 from Step 2 and multiply the result by 100% to get your ROI in the form of a percentage.
Net Profit / Cost of Investment
= $13,600 / $100,000
ROI = 0.136 x 100 = 13.6%
Advantages of Return on Investment
ROI is beneficial in many investments or business startups. It helps investors understand how well they can leverage their current assets to produce more assets.
The Return on Investment calculation is an easy way for an investor to measure how profitable investment can be.
The following are added advantages of ROI:
- Shows Your Success in Investing
You can only measure your success in investments from your returns. The quality of an investment is measured using ROI.
- Helps to Predict the Financial Growth of Your Business or Capital
ROI can help you predict how much growth your business can achieve by buying more assets or increasing marketing advert spending to expand sales.
Disadvantages of Return on Investment
ROI is beneficial in some aspects. It has been observed that it does have the following shortcomings:
- ROI is affected by Time
There are two types of investment terms; short-term and long-term investment periods.
For example, in real estate investments, if there is no rental demand for your property, it is an indication that homes are abundant in your area.
- ROI can be overhyped
This often happens when calculating ROI without taking into consideration all the expenses that may be incurred while purchasing or selling off assets or stocks.
Buying an asset that makes you incur expenses may leave you in regret.
- ROI does not indicate Risk Level
The ROI of two investments when compared only shows the yield you stand to gain as an investor. If Option A has the capacity of 50% in ROI but the risk level is 90% and Option B only has an ROI capacity of 30% with a risk level of 20%, Option B may be the best choice in this case.
Calculation of ROI will not indicate the risk level of an investment when making your choice.
Investing in the various categories of investment above is not where the wisdom is but taking time to analyze each category before committing your resources to it.
To be a successful investor in 2022, you must pay attention to markets and shun false claims because they will be offers that will tempt even the self-proclaimed experts.
You may employ the ROI calculation too to help you find the investment with the highest ROI but do not forget to consider the fact that it does not indicate the risk involved.