No matter which asset class you choose to invest in, knowing the expected return on your investment is crucial. This value should form the bedrock on which all investment decisions are made. As we will see later on, we need to factor unique variables into our expected return on investment calculator, in order to achieve accurate values for each asset class. Below, we will discuss the basics of ROI and what to consider when investing.
Introduction to ROI
On the face of it, ROI is quite an easy term to get your head around. To calculate it, we need to subtract the cost of the investment, from the gain and then divide the total by the overall cost. Or:
ROI = (Total Income – Costs)/Cost
For example, if you have a portfolio on Bitbond which contains 20 loans at $10 a loan, your lending cost is $200. If the loans have an interest rate of 20% each, you will earn $40 in interest and receive your principal $200 back at the end of the loan term. This brings the total to $240 with an ROI of 20%.
0.2 = (240-200)/200
ROI is particularly valuable because it represents values as percentages, which helps to clear up confusion. Reports detailing only the earnings, without considering the required cost are a dangerous proposition to business, and should be avoided.
To illustrate this points, let’s assume your friend Steven made $200,000 last year, and your friend Anne only made $20,000. Most people would assume Steven had the better year in terms of finances. If, we take cost into consideration however, and calculate the ROI, we might see that Steven made that money from the sale of a house which he purchased for $185,000. Anne on the other hand made her money without having to invest any herself. Thus, Steven’s ROI is $15,000, while Anne’s is $20,000.
Without understanding the costs of the investment, we cannot make any accurate conclusions about the return.
Most common investments and their risks
Peer-to-peer (p2p) investments are transmitted from you (the lender) to the borrower, with the condition that the loan be repaid to the lender in full, plus interest. The interest earned (6%-40%) on p2p investments is significantly higher than interest one many other fixed income asset classes, because the risk of non-repayment is relatively high.
With that in mind, most p2p lending platforms categorise borrowers by their creditworthiness, giving investors a good idea of the risk involved.
Apart from the invested amount, fees might also contribute to the total cost. These vary significantly, and only a few, Bitbond for example, charge none.
With the costs and the earnings now understood, we need to factor in for unique variables. In this case, it would be the default rate. This is the rate at which borrowers fail to repay their loans. The industry average is around 5%-8%. Be sure to account for the default rate when calculating your expected return on investment.
Real Estate has quickly overtaken Stocks as the most popular investment. It is not difficult to see why, with house prices rising by the day and potential ROIs at astronomical levels. First and foremost, Real estate can create returns in two ways, renting and selling.
Income from rent might seem like an attractive option, but keep the unremitting costs in mind which will deflate your ROI, such as taxes, insurance, upkeep and purchase cost.
Selling has been the safer option in recent years, although the appreciation of your property will take time, a factor we will go into later.
Stocks have proved the making of some and the downfall of many. The riskiest of all the investment types listed, Stock prices are almost impossible to predict over longer periods of time.
In addition to the risk, the cost of stocks might further dampen their appeal. The buying and selling of which comes with fees, which cut into your ROI. Ignoring these costs, routinely causes flattering distortions between the perceived ROI and the actual return on your investments.
IRR or ROI?
The two most popular measures of investment performance are the Internal Rate of Return (IRR) and the Return on Investment (ROI). IRR is preferable when finding out the annual growth rate, while ROI is better to ascertain the total growth.
Over the course of one year, these values should be the same, but diverge over longer periods.
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