How to Calculate Rate of Return (RoR)

Rate of Return (RoR) is the net profit or loss on an investment over a specific time period. It’s typically expressed as a percentage of the investment’s initial cost.

For example, if the current value of an investment you bought six months ago is $50,000, and its initial value was $40,000, then the rate of return on the asset would be $10,000 (net profit) over $40,000 or 25%.

Simple, right? But there’s more to it than that. Besides investments, the RoR can apply to corporate profits, real estate, the return on capital expenditure, and more. In addition, there are multiple ways to calculate the RoR beyond the simple calculation in our previous example.

• What is the Rate of Return (RoR)?
• Calculating rate of return
• Rate of return for stocks and bonds
• Nominal rate of return vs. real rate of return
• 6 other ways to measure returns

What is the Rate of Return (RoR)?

Rate of return is the percentage that your investment has grown or shrunk over a specific period of time. When the RoR is positive, it’s considered a profit; when the RoR is negative, it reflects a loss on the investment.

RoR can be used to measure almost all types of investments, from the investment home you own to stocks, bonds, mutual funds, and the savings account held by your business. Calculating returns provides important information that can be used while deciding future investments, and allows you to critically measure your investment against alternative options.

Calculating rate of return

We can calculate the rate of return by using the cost of the investment (or the initial investment value) and its current value. The rate of return formula is:

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Elements of the RoR formula

• Initial value refers to the original value at the time of investing.
• Current value refers to the present-day value of the investment.

This formula doesn’t consider the time frame. An RoR that doesn’t specifically mention time is assumed to be over a one-year period, and the return is known as annual return.‍

A practical example

Let’s assume you bought a share of stock worth $100 a year ago. Now, that share is worth $115. To find the rate of return, your calculation would be:

If you were to sell your share, this investment would have a 15% rate of return.

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Rate of return for stocks and bonds

RoR works differently for equity and consists mainly of dividends and capital gains. For example, let’s assume you buy a stock worth $60, hold on to it for a number of years, and earn a total amount of $15 in dividends.

If you decide to sell the stock for $90, your profit per share is $90 - $60 = $30. In addition, you earned $15 in dividend income, so your total gain is $45. The RoR for the shares is a $45 gain per share divided by the $60 cost per share, so 75%.

The formula for the rate of return on stocks or bonds is:

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Nominal rate of return vs. real rate of return

The simple rate of return we’ve discussed so far is considered a nominal rate of return since it doesn’t account for inflation over time. If an initial investment generated a 40% return, the nominal rate would also be 40%.

However, inflation reduces the purchasing power of money. In other words, $50,000 10 years from now won’t have the same value as $50,000 today. Once you factor in inflation, we call it the real rate of return (or the inflation-adjusted rate of return). This rate is likely lower than the nominal rate. Here’s the formula for the Real RoR:

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Both the rate of nominal return and rate of inflation are expressed as the result of their percentage fractions. Simply put, if the inflation rate is 50% over a period of time, it’ll be plugged in as 0.5 (which is simply 50/100) into the formula. The same principle applies to nominal RoR.

6 other ways to measure returns

Calculating return as the appreciation (or depreciation) of the value of an asset is one of the many ways of looking at the rate of return. In finance, we use different return-based metrics to learn more about a business and its financials. While these are fundamentally all rates of return, they operate under different restrictions/conditions and mean different things.

Compound Annual Growth Rate (CAGR)

The Compound Annual Growth Rate (CAGR) is a way of measuring how much your initial investment has grown, on average, per year. Because it's a very accurate metric, it's also used to express the possible future growth of businesses, industries, and even markets. The calculation factors in growth over multiple periods, so it’s useful for comparing investments.

Here’s the formula for calculating CAGR:

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Where Vfinal refers to the final value, Vbegin refers to the original value and t equals the time (in years).

Note that the CAGR doesn’t tell you how much an investment’s value has grown in a given year, but it does give you a basis for comparison.

Internal Rate of Return (IRR)

The Internal Rate of Return (IRR) is the discount rate that makes the Net Present Value (NPV) of all cash flows zero. It’s also known as the expected compound annual rate of return earned on a project or an investment.

IRR is calculated using the same concept as NPV, but it’s not the actual value. IRR is just the annual return that makes the NPV equal to zero. Here’s the formula:

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Where N refers to the total number of periods, n refers to a non-negative integer, Cn refers to cash flow, and r is the internal rate of return.

The IRR process takes the cash inflows and outflows projected from the expenditure and aims to calculate a discount rate that brings the NPV of these cash flows to zero.

However, it’s hard to calculate the IRR because you need to keep adjusting the numbers until the NPV is equal to 0. So, for example, if the NPV is a large figure, you’d make a big adjustment in the IRR to bring it closer to 0. This is a continuous trial-and-error process until the NPV finally reaches 0.

However, as you can imagine, this is massively time-consuming and annoying. Most financial analysts today use the IRR function that’s readily available in Excel to calculate the IRR such that the NPV equals 0.

Return on Equity (ROE)

Return on Equity (ROE) is a measure of financial outcome calculated by dividing net income by the average shareholder equity. Because the equity is equal to a company’s assets minus its debt, ROE is considered the return on net assets.

Here’s the formula:

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Net income is the income, net expenses, and taxes generated within a given period. Average shareholder equity is calculated by adding equity at the beginning of that period. ROE can be thought of as a meter of a business’s profitability and its efficiency in generating profits.

Return on Assets (ROA)

Return on Assets (ROA) indicates a company’s profitability with regard to its total assets. It’s often used by management, analysts, and investors to determine whether a company is using its assets efficiently to generate profits.

You can calculate a company’s ROA using the following formula:

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We take average total assets as a denominator because the total number and value of assets owned by a company keep changing and their mean can act as a reliable base.

ROA factors in a company’s debt, while ROE does not. It’s best to compare the ROA of companies within the same industry, as they share the same asset base.

Return on Investment (ROI)

Return on Investment (ROI) is used to evaluate the efficiency of an investment or to compare the efficiency of different investments. ROI tries to directly measure the return on a particular investment relative to its cost. It’s usually expressed as a percentage.

The ROI formula is very similar to RoR using the initial cost of the investment, which is subtracted from its current value. The result is then divided by the initial cost.

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ROI can be used to make direct comparisons and rank investments across different projects or assets. However, it doesn’t consider the investment’s holding period.

Return on Invested Capital (ROIC)

Return on Invested Capital (ROIC) is a measure of how much money a company makes above what it pays, on average, for its debt and equity capital. ROIC is an assessment of the company’s efficiency at allocating its capital to profitable investments.

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Total invested capital is the sum of a company’s debts and equity. ROIC can be used to calculate a company’s value. If a company’s ROIC exceeds its weighted average cost of capital (WACC), it’s allocating invested capital efficiently.

Need more financial help?

Although the rate of return formula may seem simple enough, its results are crucial for making major financial moves (like potential investment decisions) and in matters of effective capital allocation. You should ensure your calculations and understanding of RoR are accurate.

If this isn’t your area of expertise, however, we recommend engaging independent financial analysts or related experts on Upwork to help you with wealth management, financial planning, and capital budgeting.

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