You have a pool of available funds that don’t require an immediate use in the company. Then you decide to invest it and you look at different options in the market: stocks, deposits, bonds, a new machine, a computer, a building… It doesn’t matter, the most important is that it meets the definition of an asset.

When we decide to invest our available funds, we do it, naturally, for the single purpose to increase our wealth. However, one important indicator is the Return on Investment, also known as ROI and it is usually expressed as a percentage.

But how does it work? The most basic formula is simply what your profit is after investing a certain amount of funds. For example, if you invest 10,000.00 euro and you receive 12,000.00 euro, you made a profit of 2,000.00, which makes a 20% of ROI. Simple right?

However, sometimes it’s not that straightforward. In the future, it’s very difficult to predict whenever you’re obtaining the desired return on your investment. Unless you have very good forecasting skills that can help you make a decision or not, there are some considerations to be taken into account when it comes to it.

Think in terms of ROI

Either you went to the university to study a degree, bought a new computer, even though some of these activities may not have an immediate financial profit, the decision you are making it is because they can generate a benefit for you at some point in the future. Either you’re investing your money or time in an activity, as long as your goal is to increase your wealth, your decision is based on a Return On Investment.

To make it easier to understand, you could ask yourself, for example, the following questions before making business decisions:

How much will acquiring a new building increase my capacity to generate profits?

How much wealth will a new employee bring to the company?

How many new customers will this marketing campaign attract and the impact on sales?

How much savings will the automation of this process generate?

How much money will I get in form of dividends after acquiring new stocks?

How much will my brand be worth if I invest in redesigning it?

As you can see, even though we express the ROI in a percentage, thinking about the benefits we can reap is the mindset we need to have when making investment decisions.

The higher the ROI, the higher the risk

Sometimes you may expect that an investment will always bring great profits. However, thinking this way is a mistake. Let’s see why:

In terms of a ROI, let’s imagine that between two investment decisions, one offers an expected return of 5% and another one of 20% for the same amount of money invested. Which one will you choose? What is the right answer? Actually, there is no right answer for this. Your choice won’t usually depend only on the information you have, the amount of funds involved, but also in your risk tolerance or attitude to risk, among other variables.

For example, investing in the stock market may have the potential to offer this expected ROI of 20%. However, these type of assets are well known for its high volatility, which can make you earn a lot of a money, but also lose it. Just look at the banks when they offer a loan, sometimes they may rise the charged interest depending on the level of the risk (in this case, their interest would be their ROI) or ask you to provide some guarantees, as they do with mortgages. In case you can’t pay they will seize your house. This helps the financial entities to manage the risk of lending you money for your new home.

However, in contrast, if the ROI is expected to be low, the asset you’re investing in may be of lower risk (for example, bank deposits).

So, what do you think about the ROI? Did you find it useful? If you have a new questions, concerns, or you need advice, feel free to drop me a message or send me an email.