Guide · Savings & Investing
ROI Explained: How to Compare Investments on a Like-for-Like Basis
Return on investment is one of the most quoted numbers in finance — and one of the most misused. A 50% ROI sounds great until you discover it took ten years to achieve. Here is how to calculate ROI properly, annualise it, and use it to compare any two investments fairly.
The basic ROI formula — and its flaw
Return on investment is straightforward:
ROI formula
ROI = (Gain − Cost) ÷ Cost × 100
Gain = total proceeds including income received · Cost = total cash invested
If you invest £10,000 and receive £15,000 back, ROI = (£15,000 − £10,000) ÷ £10,000 × 100 = 50%. Simple and useful when comparing investments held for the same period. The flaw appears when time differs: a 50% ROI over 2 years is vastly better than 50% over 10 years. Simple ROI treats them identically.
The fix is annualised ROI, also called CAGR (compound annual growth rate):
Annualised ROI / CAGR formula
CAGR = (1 + ROI)^(1 ÷ years) − 1
Converts a multi-year total return into the equivalent steady annual rate
Four investments compared
The table below applies both metrics to four real-world investment types. All costs are included in the calculation — buying costs, taxes, and fees where relevant.
| Investment | In | Out | Years | Total ROI | Annualised ROI |
|---|---|---|---|---|---|
| Property (incl. £15k costs) | £215,000 | £320,000 | 5 | 48.8% | 8.4% |
| Stock market (global index) | £10,000 | £18,500 | 7 | 85.0% | 9.2% |
| Savings account (4.5% AER) | £10,000 | £11,412 | 3 | 14.1% | 4.5% |
| Business investment | £50,000 | £120,000 | 4 | 140.0% | 24.4% |
The business investment has by far the highest total ROI and annualised ROI, but it also carried the greatest risk — most business investments fail entirely. The stock market beats property on annualised return here with no management burden. The savings account delivers the lowest return but with zero risk to capital.
When to use simple ROI vs CAGR
Simple ROI is perfectly adequate when you are comparing investments over the same time horizon. If you are choosing between two five-year bonds, or evaluating which of two marketing campaigns delivered more profit from the same budget over the same quarter, total ROI is all you need.
Use CAGR whenever the time periods differ. Comparing a property held for five years against shares held for seven years using simple ROI will mislead you. CAGR puts both on an annual rate basis so the comparison is genuinely apples-to-apples.
CAGR is also the standard metric used by fund managers and in financial reporting. When a fund advertises a “10-year annualised return of 8.3%”, that is CAGR. It tells you the steady annual rate that would have produced the fund's actual ten-year total return.
ROI does not capture risk
The biggest limitation of ROI is that it ignores risk. A 20% annualised ROI from a highly speculative venture is not obviously better than 8% from a diversified equity fund. The speculative venture could just as easily have delivered −100%.
Risk-adjusted measures like the Sharpe ratio correct for this by dividing excess return by volatility. For most individual investors, the practical approach is simpler: ask whether the higher-ROI option could realistically have lost all or most of your money, and whether the extra return is proportionate to that possibility. Consistent 8–9% CAGR from a global index fund has historically beaten many higher-looking but riskier alternatives on a risk-adjusted basis over the long run.
Frequently asked questions
What is a good ROI?
It depends entirely on the asset class and risk involved. The UK stock market has delivered roughly 7–9% annualised total return over the long run. A savings account at 4–5% is a good ROI for a risk-free asset. Property has historically returned 5–8% annualised including rental income. A business investment returning 15–20% annualised is excellent. The key benchmark is always: could I get a similar return with less risk elsewhere? A high ROI from a risky venture is not necessarily better than a moderate ROI from a stable one.
What is the difference between ROI and CAGR?
ROI (return on investment) is a simple percentage gain over the full holding period with no reference to time. CAGR (compound annual growth rate) is the annualised equivalent — the steady annual rate that would produce the same total gain over the same number of years. They are mathematically related: CAGR = (1 + ROI)^(1/years) − 1. CAGR is more useful for comparisons because it puts investments held for different durations on the same footing.
Does ROI include inflation?
Standard ROI calculations use nominal figures — actual pounds or dollars, not adjusted for inflation. A 6% ROI in a year with 4% inflation gives a real return of only about 2%. For long-term comparisons, it is worth calculating real ROI by adjusting for CPI. Many investors use a rough rule: subtract the inflation rate from the nominal return to estimate real return. For rigorous analysis, divide (1 + nominal return) by (1 + inflation rate) and subtract 1.
How do I calculate ROI on a rental property?
Rental property ROI should include all costs and all income. Total gain = rental income received + (sale price − purchase price) − all costs (stamp duty, legal fees, maintenance, letting agent fees, mortgage interest, insurance, void periods). ROI = total gain ÷ total cash invested × 100. For annualised ROI, apply the CAGR formula using the number of years held. Many landlords also calculate yield separately: annual rental income ÷ property value × 100 to measure the income component alone.