How to use a ROI

aurora borealis
Introduction:

ROI is a comparative financial performance measure that stands for return on investment.  The technical formula for ROI is:

(gain from investment – cost of investment) / (cost of investment)

In other words the formula is simply net profit divided by total cost.

To put it in concrete terms, let’s say that someone invests $100 in books about how to code.  After they read the books, they start a small side business doing contract programming work from home.  At the end of the first year they’ve made $5,100 dollars with the coding business.  So to calculate the first year ROI, it would simply be profit divided by total cost, or $5,000 divided by $100, which equals 50.  Since ROI’s are usually expressed in percentage terms, that would be an ROI of 5,000%.

If this person continued to make $5,000 a year from their new coding business, the 10-year ROI would be about 10 times larger, so it doesn’t really make sense to compare ROI’s across different time periods.  That is why I use the same 10-year timeframe for all my analyses.

There are some investments, however, that deserve to be evaluated on a longer time frame, such as the value of a college education for example.  Another one that comes to mind is the impact of high fees on mutual funds and ETF’s.  For most scenarios, however, 10 years seems to work pretty well.

How to use a ROI:

I sort all of my ROI analyses by total value rather than their 10-year ROI to highlight the “investments” with the largest impact.  But working down that list would technically be an inefficient way to go.

The appropriate way to use a ROI, assuming one has a lump sum of money and is looking strictly at 10-year investments, is to start with the highest percentage ROI first and move down from there.  Even if the total value of the ROI is just a few pennies, it makes sense to prioritize a 5000% ROI above a 10% ROI.

The reasoning is that higher ROI’s tie up less cash.  A really big value but low ROI investment like making four extra meals at home per week ($17,000 value and 88% ROI) would tie up a large chunk of your money for 10 years when it probably would have been better to pick a few smaller value but higher-performance ROI’s like making your own coffee ($5,000 | 650%), cutting your own hair ($3,450 | 500%), getting a smart thermostat ($1,200 | 450%), etc.  This way, you could make the same amount of money with less initial investment, leaving excess cash to invest in even more things.

coffee

So in the spirit of starting with the highest ROI and working down, here are the top 10 ROI analyses so far…

Top 10 ROI Scores:

(present value | ROI | payback period)

  1. Get rid of cable :: $7,403 | 12,338% | 0.1 years
  2. Work from home, get rid of car :: $106,106 | 1,768% | 0.1 years
  3. Cut your own hair (gals) :: $6,078 | 1,326% | 0.1 years
  4. Investing in low-cost ETFs :: | $15,284 | 1,243% | 0.1 years
  5. Not buying an electric toothbrush :: $589 | 982% | 0.1 years
  6. Work from home, keep car and other driving :: $49,917 | 832% | 0.2 years
  7. Sell car, buy bike (with exercise $$) :: $260,826| 743% | 0.1 years
  8. Make your own coffee before work :: $5,230 | 647% | 0.2 years
  9. Drinking at home instead of bars :: $12,986 | 624% | 0.2 years
  10. Cut your own hair (guys) :: $3,454 | 512% | 0.3 years

The list will likely change as I keep evaluating different scenarios, but I don’t plan on updating this post… the new ones will all be listed on the ROI Scoreboard anyway.

And that’s it for today.  Spend (invest) well!

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