Hi and welcome to another issue of short notes - a series where I write short notes on topics I find interesting enough.
This week was a little less busy than the previous week. However, I am currently preparing for my exams which starts on Tuesday. Don’t forget to share
ROI is the abbreviation of Return On Investment. Used to determine the returns on one’s investment. You could call it profit, but investments and business aren’t the same. So let’s stick to ROI thanks to lexis and registers.
ROI is calculated by subtracting the initial value of the investment from the final value of the investment (which equals the net return), then dividing this new number (the net return) by the cost of the investment, and, finally, multiplying it by 100.
While this is straight forward, there are two things not accounted for, duration and ROI adjusting for inflation. What if Mr B duration was 10 years? What if inflation was 10% for Mr B.
The above is a nominal ROI or called ROI.
When inflation and other external factors are considered, the ROI calculated is the real ROI.
The real ROI (adjusted for inflation) = ROI(nominal) - Inflation rate.
With the above table, it is easy to see how inflation can eat into one’s return. And yes, according to this table, Mr A’s investment yield more than Mr B’s.
Another is risk-adjusted ROI, which deals with the risk accompanying an investment.
Risk is the degree of uncertainty and/or potential financial loss inherent in an investment decision. In general, as investment risks rise, investors seek higher returns to compensate themselves for taking such risks.
Risk is going to be another topic for another day.
Further reading on risk:
Risk and Asset Allocation I: Types of Risks
Risk and Asset Allocation II: Risk Categories
That wraps it up.
See you next week.