Return on investment (ROI) is a term that comes up regularly in the world of finance. For financial advisors, learning about ROI is not just helpful—it is necessary. Your clients want to know how their investments are performing and whether their money is working as hard as it should. ROI is one of the simplest ways to answer that question.
In this article, Wealth Professional Canada will look at what ROI means, how to calculate it, and how to interpret the numbers. We will also discuss what makes a good ROI and whether certain percentages are realistic in today’s market.
Return on investment is a metric that measures how much profit is made from an investment compared to its cost. It’s also a broad measure of profitability that helps show how efficiently a business or investment is using money to generate returns.
Shareholders often use ROI to compare different companies in the same industry or even across different industries. This helps them decide whether to increase, decrease, or hold their current investment. For your clients, ROI is a figure that shows whether their investment choices are paying off.
ROI is not just for stocks or mutual funds. It can be used to measure the performance of almost any investment, from real estate to small businesses. The key is that ROI gives a percentage that is easy to compare across different investment options. To know more about ROI, watch this video:
When conducting fundamental analysis, ROI is evaluated along with other financial metrics.
ROI is influenced by many factors such as:
Because ROI is such a broad measure, one should use it with other metrics for a more complete picture. Some of these include:
The formula for ROI is simple and direct. Take the net profit (or earnings after tax) and divide it by the total investments (total invested capital). Then, multiply the result by 100 to get a percentage.
Let’s look at an example. Suppose a company earns $20,000 after tax, and the total invested capital is $300,000. The ROI would be 6.7 percent. This means that for every dollar invested, the company made just under seven cents in profit.
There is also another way to calculate ROI, especially when looking at the buying and selling of assets like stocks:
For example, if your client buys shares for $1,000 and sells them for $1,200, the ROI would be 20 percent. This formula gives a clear percentage of the gain made on the investment.
ROI is a flexible metric, but it is important to use it correctly. Always make sure you compare similar investments and use the right numbers for net profit and total investment.
Trivia: “How is return on investment calculated?” was the sixth most Googled investment question back in 2023.
The answer to whether a seven percent ROI is good depends on several factors. There is no single number that works for every situation. What matters most is the financial needs and goals of your clients.
For example, if your clients are saving for a long-term goal like college tuition for their children, a seven percent ROI might be enough to reach their target over many years.
On the other hand, if your clients are looking for a steady income, they might need a different rate of return to meet their living expenses.
A five percent ROI is a realistic target for many investments, especially those that are lower risk. For example, some bonds and high-quality dividend stocks might deliver returns in this range over the long term.
It is vital for your clients to set expectations. ROI is not guaranteed. Market conditions, interest rates, and other factors can cause returns to go up or down. What looks realistic in one year might not be the case in another.
When talking to your clients about ROI, it is beneficial to explain that posted ROI numbers are not set in stone. They are forecasts based on past performance and current conditions. Your clients could earn more than the expected ROI, but they could also earn less.
Another point to consider is that simple ROI calculations do not factor in time. For example, a five percent ROI over one year is very different from a five percent ROI over five years. That's why you should look at how long it takes to achieve the return, not just the percentage itself.
ROI also doesn’t account for market risk. Even if an investment has delivered a five percent ROI in the past, there is no guarantee it will do so in the future.
A good ROI ratio is one that matches the financial goals, risk tolerance, and investment timeline of your clients. There is no universal answer, but there are some general guidelines that financial advisors can use.
When it comes to stocks, especially over the long term, many investors look for an average annual ROI of 10 percent or more. For low-risk investments such as government bonds, an ROI of eight percent is considered strong.
Still, these numbers are just averages; actual returns will change from year to year.
Let's use sample scenarios. A young family saving for college will see a good ROI as one that helps them reach their goal in time. For a retiree, a good ROI is one that provides enough income to live comfortably. These definitions will always change from person to person.
As mentioned above, risk is also a factor. The higher the risk of an investment, the higher the expected ROI should be. Investors should be aware that higher returns usually come with higher risk.
It is also important to look at ROI in the context of the entire portfolio. Diversification can help manage risk and improve the chances of achieving a good ROI. This means:
Watch this video to discover what a good rate of ROI is:
While you cannot control everything that affects ROI, there are several strategies that you can use to help your clients maximize their returns over time:
Encourage your clients to make regular contributions, even during market downturns. This can help smooth out the effects of market volatility and take advantage of lower prices when markets are down.
Dollar-cost averaging is a good way to invest the same amount at regular intervals, buying more shares when prices are low and fewer when prices are high.
Investment fees can eat into returns over time. Help your clients choose low-cost funds and brokerages. Even small differences in fees can add up to big differences in portfolio value over the years.
Placing investments in accounts like the Tax-free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) can help your clients keep more of their earnings. TFSAs allow investments to grow tax-free, while RRSPs let contributions grow tax-deferred until withdrawal.
Spreading investments across different sectors and asset types can help reduce risk and improve the chances of a good ROI. This includes stocks, bonds, real estate, and other assets.
Remind your clients that investing is a long-term game. Trying to earn profits quickly or timing the market can lead to losses. A steady, patient approach usually delivers better results over time.
Return on investment provides a simple yet clear way to measure how well investments are performing. While ROI has its limitations, especially when it comes to time and risk, it’s still a useful measure for comparing investment options and tracking progress.
A good ROI is not the same for everyone. It depends on many factors, so remember to use it alongside other metrics. Always consider the unique needs of your clients. With strategies such as consistent investing and using tax-efficient accounts, you can help investors work toward the returns they need.
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