How to Calculate Return on Investment

An investor cannot evaluate any investment, whether it’s a stock, bond, rental property, collectible or option, without first understanding how to calculate return on investment (ROI).This calculation serves as the base from which all informed investment decisions are made and, although the calculation remains constant, there are unique variables that different types of investment bring to the equation. In this article, we’ll cover the basics of ROI and some of the factors to consider when using it in your investment decisions.

On paper, ROI could not be simpler.To calculate it, you simply take the gain of an investment, subtract the cost of the investment, and divide the total by the cost of the investment. Or:

ROI = (Gains – Cost)/Cost

One major factor that doesn’t appear in an ROI calculation is time. Imagine investment A with an ROI of 1,000% and investment B with an ROI of 50%. Easy call – put your money in the 1,000% one. But, what if investment A takes 30 years to pay off and investment B pays off in a month? This is when time periods come into play.

Often it is easier to compare one investment to another by dividing the ROI by the number of years each one takes to mature. On a side note, to determine how long until your original investment will double, you divide 72 by the ROI.

The Bottom Line

ROI is a useful starting point for sizing up any investment. Remember that ROI is a historical measure, meaning it calculates all the past returns. An investment can do very well in the past and still falter in the future. For example, many stocks can yield ROIs of 200-500% during their growth stage and then fall down to the single digits as they mature. If you invested late based on the historical ROI, you will be disappointed. Projected or expected ROIs on an unproven (new) investment are even more uncertain with no data to back it up. For this reason, Investors must perform their due diligence and have a plan in place before making the investment. Otherwise, they are speculators.

Your Personal Wealth Ratio

In order to properly understand the purpose of a wealth ratio, we will first define wealth.

Definition of Wealth: The number of days you can survive without working.

What is a Wealth Ratio?

Your personal wealth ratio is the amount of passive income divided by your expenses.

Passive Income = Wealth RatioExpenses

If you have ever played Cashflow 101 or 202, you understand that when your wealth ratio is >1 you are technically out of the “rat race” and are financially free. This is because your passive income is greater than your living expenses allowing you to have an infinite number of days you could survive without working.

How to Increase Your Personal Wealth Ratio

There are two ways to raise your wealth ratio to 1 or greater. One is to raise your passive income, the other is to reduce your expenses. By choosing great passive income opportunities, you will be on your way to financial freedom. At the same time you can reduce your expenses. I recommend you take a look at your expenses each month and figure out what you need to make each month to live. Then set goals in order to move your personal wealth ratio to become greater than 1.

When your passive income is greater than your expenses, technically you be wealthy. This is how rich people switch to becoming wealthy people.

See you at the top!

Who’s influencing you?

Birds of a feather flock together. The people with whom you habitually associate are called your “reference group.” According to research by social psychologist Dr David McCelland (Harvard), your “reference group” determines as much as 95% of your success and failure in life.

  • Who do you spend the most time with?
  • Who are the people you most admire?
  • Are those two groups of people the same?
  • If not, why not?

We become the combined average of the 5 people we associate with most. The quality of our health, our attitudes, and our income can be determined by looking at the people around us. The people with whom we spend our time determine the topics of conversation that dominate our attention, and the attitudes and opinions to which we are regularly exposed. Eventually we start to eat what they eat, talk like they talk, watch what they watch, read what they read, think like they think, and even dress like  them.

Think of your friends who order greasy appetizers or cocktails before dinner, as part of their routine. Hang out with them long enough and you’ll find yourself grabbing for cheese nachos and potato skins, and joining them for that extra beer or glass of wine, eventually matching their pace. Meanwhile, your other friends order healthy food and talk about the inspiring books they are reading (or the latest issue of DealFlow Monthly) and their ambitions in their business and investments. You begin to assimilate their attitudes, behaviors and habits. You read and talk about what they talk about, the the movies they are excited about, and you go to the places they recommend. The influence of your friends on you is subtle and can be positive or negative.

It may be time to re-appraise and re-prioritize the people you spend time with. These relationships can nurture you, starve you, or keep you stuck.

You cannot hang out with negative people and expect to live a positive life.