How to Calculate the Rate of Return
The rate of return (RoR) is an important metric in finance, used to measure the performance of an investment or to compare different investments. It helps you understand whether your investment has been profitable, and how well it performed compared to other options. In this article, we’ll explain how to calculate the rate of return and provide examples for better understanding.
What is Rate of Return?
The rate of return is a percentage that represents the gain or loss made on an investment over a specific period. It’s an essential tool for not only evaluating the past performance of investments but also making projections about how well they might perform in the future.
Steps to Calculate Rate of Return:
1. Determine your initial investment value: This is the amount you initially paid for the investment. For example, if you bought 100 shares at $10 per share, your initial investment value would be $1,000.
2. Determine your ending investment value: This is the current market value of your investment or its worth when you sold it. Continuing with the previous example, imagine that today each share is worth $15; your ending investment value would be $1,500 (100 shares * $15).
3. Calculate the gain or loss: Subtract the initial investment value from your ending investment value. Using our example above:
Gain = Ending Investment Value – Initial Investment Value
Gain = $1,500 – $1,000
Gain = $500
4. Calculate the rate of return: Divide the gain or loss by the initial investment and multiply by 100 to obtain a percentage.
Rate of Return = (Gain / Initial Investment Value) * 100
Rate of Return = ($500 / $1,000) * 100
Rate of Return = 50%
So in our example, you would have gained a 50% return on your initial investment.
The rate of return calculation is a simple and effective method to analyze the performance of an investment or compare different investment options. By understanding and calculating the rate of return, you can better allocate your capital and make informed investment decisions. Keep in mind that past performance does not guarantee future results, so it’s essential to use other financial ratios and indicators for a well-rounded assessment.