- Importance of ROI
- How to Calculate ROI
- Limitations of ROI
- Annualized ROI
Investing in cryptocurrencies is pretty straightforward and hassle-free. Often, investors can easily tell how much profit they have made; at other times, people with vast crypto portfolios may find it challenging to keep track of all their investments; hence, knowing their exact returns may be challenging. Regardless of which end of the spectrum you are, it is vital for any cryptocurrency investor to know how to calculate their Returns on Investment (ROI). This sheds light on the outcome of your investment strategy and may help you restrategize your investment style.
What is Return on Investment (ROI)?
As an investor, your Return on investment (ROI) is the measure of your investment’s increase in value in a specific period; it is the profit percentage accrued on an investment (whether a crypto investment or not). ROI is a financial instrument used to assess the efficiency of your investment strategy. Hence, comparing the ROI of two different assets with contrasting investment strategies could help you find out the best approach for your crypto investments.
Of course, ROI is merely an informative tool; it cannot be solely used to make crucial investment decisions. To make critical investment decisions, you are expected to do your due diligence, performing technical and fundamental analyses.
How to Calculate the ROI of an Investment?
Calculating your ROI involves basic arithmetic; hence, anybody with elementary mathematics knowledge can calculate their ROI as explained thus;
X = The current value of the investment.
Y = The initial value of the investment
Z = The extra expenses incurred on the investment.
ROI = ((X-Z) – Y) ÷ Y × 100%
Suppose you buy 5 units of Bitcoin in November 2020 at $8,000 each with a total transaction fee of $100 before transferring it to a cold wallet for another $120. If, after a year, each Bitcoin unit is worth $65,000, your ROI will be calculated thus;
X = $65,000 × 5 = $325,000
Y = $8,000 × 5 = $40,000
Z = $100 + $120 = $220
ROI = ((325,000 – 220) – 40,000)/40,000 × 100%
Hence, ROI = (284,780/40,000) × 100%
ROI = 7.1195× 100%
ROI = 711.95%
N.B.: Some ROI computations fail to account for the extra costs of investment. Typically, these extra costs may be negligible in cryptocurrency investments due to high returns; however, there could be a significant difference in small-scale investments.
If the $220 in transaction fees are unaccounted for in the example above, the ROI will be 712.5% (which isn’t significant enough to affect the ROI of a $325,000 worth of investment).
The limitations of ROI Computations
1. The ROI doesn’t depict complete investment information and could be slightly misleading. For example, if the Bitcoin at 65,000 as of 2021 is now $30,000 as of 2022, the ROI is still positive because $30,000 is way higher than $8,000 (the initial investment price). However, in a real sense, the investment gained 712% from 2020 to 2021 but has lost 54% value from 2021 to 2022. ROI doesn’t consider all these; hence, the overall ROI from $8,000 per unit in 2020 to $30,000 in 2022 remains positive (275%), whereas the investment has recently lost value.
2. Furthermore, the shorter the period required to generate an ROI, the more lucrative the investment is. For example, an investment that produces an ROI of 500% in 6 months is more lucrative than one that produces the same in 3 years. To solve this dilemma of time-money value, investors employ the Annualized ROI model.
What Is Annualized ROI?
Annualized ROI helps to see the ROI of an investment with a proper perspective. It accounts for the average annual ROI by considering each year in the investment period individually.
The formula for annualized ROI is:
A – ROI = ((1 + ROI) 1/n – 1) × 100%
Where “n” = the number of years in the investment period
Calculating the ROI of an investment that appreciates from $100,000 to $150,000 over a period of ten years will be 50%; however, the annualized ROI will be
A – ROI = ((1+0.5)) 1/10 – 1) × 100%
A – ROI = ((1.5)0.1 – 1) × 100%
A – ROI = (1.0414 – 1) × 100%
A – ROI = 0.0414 × 100%
A – ROI = 4.14%
Hence, the aggregated ROI shows that the 10-year period of 50% ROI is only worth around 4.14% annually. This shows a significant distinction in performance when valued with time.
It is essential to know the state of your investments and to see how your strategies are working, and calculating your investment ROI is a good method to analyze this. However, ROI is a pretty basic tool, so it's not sophisticated enough for advanced analysis. To perform an in-depth analysis of your investment strategy, it is advisable for you to use other metrics alongside.
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