Return On Investment (ROI)
While the ROI of Joe’s second investment was twice
that of his first investment, the time between Joe’s purchase and sale was one year for his first investment and three years for his second.
If one considers that the duration of Joe’s second investment was three times as long as
that of his first, it becomes apparent that Joe should have questioned his conclusion that his second investment was the more profitable one.
Because ROI is measured as a percentage, it can be easily compared with returns from other investments,
allowing one to measure a variety of types of investments against one another.
Examples like Joe’s indicate how a cursory comparison of investments using ROI can lead one to make incorrect conclusions about their profitability.
Yet, examples like Joe’s reveal one of several limitations of using ROI, particularly when comparing investments.
Joe’s ROI for his first investment was 20% in one year and his ROI for his second investment was 40% over three.
Using ROI, Joe can easily compare the profitability of these two investments.
A return on investment ratio alone can paint a picture
that looks quite different from what one might call an “accurate” ROI calculation—one incorporating every relevant expense that has gone into the maintenance and development of an investment over the period of time in question—and investors should always be sure to consider the bigger picture.
Given that ROI does not inherently account for the amount of time during which the investment in question is taking place, this metric
can often be used in conjunction with Rate of Return, which necessarily pertains to a specified period of time, unlike ROI.