What is a Good ROI?

A good ROI can vary based on the type of investment, industry, risk tolerance, and time horizon. Typically, a good ROI is considered to be above the baseline interest rates or inflation. For example, in stock market investments, an ROI of 7-10% is generally regarded as strong, whereas in real estate, people might look for 10-15% annually. But here's the thing: ROI is not a one-size-fits-all metric. It must align with individual objectives and the specific investment environment.

Let’s consider a reverse narrative approach to break down the key elements that determine what a good ROI is. We’ll dive right into the misconceptions and mistakes first before circling back to the fundamentals that shape the ROI equation.

Why People Fail to Measure ROI Accurately

Many investors and business owners fall into the trap of underestimating the importance of the time horizon. A project that yields a 5% return over two years could be less attractive than one yielding the same over six months. The time value of money (TVM) is often forgotten. This concept highlights the idea that money today is worth more than the same sum in the future due to its potential earning capacity.

Similarly, another common failure is not accounting for all costs associated with an investment. When calculating ROI, especially in complex ventures like real estate or tech startups, people frequently neglect overhead costs, taxes, or inflation adjustments. This leads to an overly optimistic ROI, which is misleading at best and dangerous at worst.

ROI and Risk: The Key Relationship

Higher ROI often comes with higher risk. This is a truth that many new investors learn the hard way. For example, if you are getting a 15% return in the stock market, it likely means you're taking on significant risk. Meanwhile, government bonds might yield 2-4% but with almost no risk involved.

Understanding risk-adjusted returns is crucial. In fact, the Sharpe ratio is a metric that adjusts ROI by factoring in risk. A portfolio with a higher Sharpe ratio offers a better risk-adjusted return than one with a lower ratio, even if the absolute ROI is smaller. So, a “good” ROI must be viewed in light of the accompanying risk.

Real-World Examples: Good ROI in Action

In the tech world, let’s look at companies like Apple or Tesla. For early investors, ROI has been astronomically high, with over 1000% returns in a relatively short time. But these were high-risk investments in the beginning. Fast forward to today, and the S&P 500 has averaged around 8% annually, which is generally accepted as a good ROI in stock markets.

In contrast, a real estate investor might consider a 10-12% annual ROI as good, given the stability and potential for property value appreciation over time. However, there’s often significant capital tied up, and liquidity is lower than in stocks.

Calculating ROI: A Simple Yet Powerful Formula

The formula for ROI is simple:

For example, if you invest $10,000 in a business, and your profit after a year is $2,000, your ROI would be:

But, this basic calculation doesn’t account for important factors like risk, time, or opportunity cost, which brings us to the next point.

What You’re Not Measuring Could Be Hurting You

Opportunity cost is often the silent killer of ROI calculations. When you invest capital into one project, you lose the ability to invest it elsewhere. Suppose you invest $50,000 in a project that gives a 5% ROI over three years. But what if, in that same time period, you could have earned 15% elsewhere? The opportunity cost of your original investment is substantial.

Time is another key component. Imagine two scenarios: one investment that returns 8% annually for 10 years, and another that offers 8% for just 3 years. While the ROI is technically the same, the longevity of the return makes a huge difference in compounding interest over time.

Tracking and Adjusting for a Better ROI

To track ROI effectively, businesses and investors often use data dashboards that pull in metrics from different departments or markets. These systems can offer real-time insights into the performance of individual projects or investments, allowing for adjustments.

For example, a marketing campaign may show an initial ROI of 5%, but once customer acquisition costs are included, the real ROI might drop to 2%. By tracking this data regularly, businesses can make informed decisions to cut underperforming campaigns or double down on the ones that perform better.

Historical ROI Benchmarks

Historically, the S&P 500 index has provided an average return of about 8-10% annually. Real estate has averaged around 9%, and small businesses typically aim for an ROI of at least 15-25%. However, these numbers are fluid and depend on a variety of market conditions, interest rates, and economic cycles.

For a long-term investor, matching or slightly beating the average historical returns in their respective markets is often considered a success. A 10% ROI over 20 years in the stock market would be seen as a strong, sustainable return.

Conclusion: What is a Good ROI for You?

Ultimately, what defines a good ROI is personal. It depends on your goals, risk tolerance, investment horizon, and the specific nature of the investment. While 10-15% annually might sound great to one investor, another might be seeking more aggressive returns in high-growth industries.

The key takeaway is to measure ROI with all factors considered—risk, time, and opportunity costs. This way, you can ensure that you're not just seeing numbers, but interpreting them in a way that brings true value.