What is ROI?

We are in the middle of Wimbledon right now. The Netflix sports documentary team struck again with “Break Point,” and Jules and I now watch Tennis. Only the finals of the major tournaments but still, this is the third sport that we care about thanks to Netflix.

Return on Investment (ROI) is the return (profit or loss) on an investment expressed as a percentage of the total cost. You obviously want your ROI to be positive and showing your profit, but since people like investing in Barnes and Noble, we have to call it a “return” and not profit to account for the possibility of a loss. 

For the record, my ROI was -99.57% on my Barnes and Noble investment.

To calculate your ROI, you divide your profit (or loss) by your cost and multiply by 100 to get the percentage. 

ROI = (Profit or Loss) / Total Cost of Investment x 100

If you bought $1,000 of Yankee Candles and sold them for $2,000, your ROI would be 100%.

ROI = $1,000 (Profit) / $1,000 (Cost) = 1 x 100 = 100%

If you bought $1,000 of Wild Ape NFTs and sold them for $100, your ROI would be -90%.

ROI = $900 (Loss) / $1,000 (Cost) = 0.9 x 100 = -90%

When evaluating a potential investment, ROI is an important projection; however, ROI does not take time into consideration. Annualized Rate of Return (ARR) is a calculation of return per year. It takes the return divided by the length of time. Both are important to analyze because ROI can be misleading if you ignore time. To highlight this, let’s look at everyone’s favorite investment: a home. 

The year is 1994, you made $200,000 from an investment in a weird food company called “Apple.” You immediately purchased a modest, ranch style house in Palo Alto. You lived in this home for 30 years. You sold it for $1 million dollars. What would your ROI be? 

• Investment: $200,000

• Sale Price: $1,000,000

• Profit: $800,000

• ROI: 400% 

• ARR: 13.33% (repeating, of course)

Wow! A 400% return on an investment is amazing! An ARR of 13% is also fantastic! If you remember our home buying series (The Costs, Rent v. Buy, Beyond the Purchase), buying a home is not the investment you think it is. So let’s make these numbers more realistic.

• Initial Investment: $200,000

• Annual Taxes: $2,000 per year, $60,000 total

• Annual Maintenance: $2,500 per year, $75,000 total 

• Annual Insurance: $1,250 per year, $37,500 total 

• Total Investment: $372,500

• Sale Price: $1,000,000

• Realtor Commissions: 6%, $60,000

• Income Tax on profit over $500,000: 20% of $300,000 = $60,000

• Take Home: $880,000

• Profit: $507,500

• ROI: 136%

• ARR: 4.54%

Not quite what we originally thought… but this is a letter about ROI not the hidden costs of owning a home.

In both scenarios, the ROI is amazing. If you find an investment with a 136% ROI, you should be excited but cautious. Ensure you analyze the expected timeline of an investment (to include many other factors). That can help you compare it to $VOO (S&P 500 ETF) which has an ARR of 14% since 2010. Now this doesn’t mean every investment needs to beat $VOO… diversity is important. It does, however, highlight the high bar set by Index Funds and ETFs.

Now you can go to some summer BBQs and make fantastic jokes about ROI like: wow, the ROI of those bratwurst is better than the S&P 500! Or I like my ABV like my ROI, above 10%. 

You’re welcome.

What We’re Watching:

Owning Manhattan. If you have read more than two of our newsletters, you know that Jules and I love reality real estate TV shows more than anything. Owning Manhattan is a contender for our favorite one. Ryan Serhant, first in Million Dollar Listing: New York, is just on the edge of cool and trying too hard. 10/10, fantastic entertainment.

Debrief on Deck

Next week, Mike is going to talk about the difference between credit card issuers and networks and how it affects your purchases. The infrastructure required for one computer to say here is $20 and another to say “thanks” is truly shocking.

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (X (formerly Twitter) and Instagram).

Until then, stay the course.

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