People want to get returns (profit) from the investments they make. This means they’d eventually compare various investments’ (potential) returns before deciding which they’d put their money in.
The simplest and one of the most versatile ways of measuring your return is using the return on investment. Return on investment (ROI) is calculated by dividing an investment’s net profit (or loss) by its initial cost. It is a metric used to gauge the profitability of an investment and expressed in percentage.
ROI = Current Value of Investment – Cost of Investment x 100
Cost of Investment
Return on investments can provide both positive and negative returns. A negative ROI indicates loss on an investment, and a positive ROI means profit.
Investors will naturally want investments that have higher returns on investment. The larger the return, the better. However, like everything else, there is always a constraint… Risk
Now let’s talk about Risk and Return
All investments, by their very nature, have risks. Risk is the uncertainty of gaining or losing money in an investment. This makes investors careful of making investments only because of the high potential ROI.
Risk and return do have a directly proportional relationship. When the risk of an investment is high, the return is also expected to be high.
In simpler terms, the higher the potential ROI, the higher the possibility that the actual ROI will differ from an expected ROI.
Therefore, a general rule of thumb is that the more risky an investment, the higher the (potential) return.
The Rule of 72
Having understood the risk-return relationship, one might ask, how long will it take to double the cost of my investment.
The time it will take to double your investment is obtained using the Rule of 72. When faced with a complex explanation of return on your investment, you can use this rule to know how long it will take for your investment to double.
The Rule of 72 is a quick, helpful formula popularly used to estimate the number of years required to double the invested money at a given annual rate of return.
It is calculated as thus:
Rate of Return
Time: is the time it takes your money to double.
Rate of return: Is the ROI of your investment
Using the previous example where Mo has a return of 20%. The time it will take Mo to double his money is:
72/20 = 3.6 years.
It will take Mo 3.6 years to double his money at a rate of 20% annually.