A Comprehensive Guide to Return On Investment
People work hard to earn money so they can not only live comfortably but also save for the future. The purpose of an investment is to make more money by investing the hard-earned money. You can do this in a multitude of ways so that your money is effectively invested and yields profit. Yet, how can we tell if we’ve made money from our investment? Using Return on Investment (ROI), we can evaluate or compare the efficiency of our investments and gauge the profitability of each one.
How to calculate ROI?
Return on investment is also called the rate of yield or rate of return and can be calculated in many ways.
To calculate the ROI, subtract the initial value of an investment from the final value of the investment (which equals the net return). Then divide the net returns by the initial value of the investment, and multiply it by 100.
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In other words, the simple formula to calculate the ROI is:
Gain from the investment – initial value of the investment X 100
initial value of the investment
The bigger the percentage, the higher the gains accumulated. ROI is always expressed in terms of percentage.
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Take a look at the following example, to help you better understand the calculation of ROI:
If you have invested Rs. 80,000 in an equity fund and after the maturity period of 3 years it becomes Rs. 1,00,000.[(100000 – 80000)/80000] x 100 = 25%
The return on investment on the mutual funds is 25% over 3 years, which is a cumulative amount. The same can be calculated annually to see the return on investment every year.
The formula to calculate annualized returns or AROI is [(1+ROI)^1/n – 1]*100, where ROI is the return on investment and n is the number of years. You may use a decimal if the time has been less than a year or part of the year. For example, 2/2.5 if you have held an investment for two years and a half.
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Taking the same example from above, if your return on investment is 25% over 3 years, the AROI would be:
[(1+25%)^1/3 – 1]*100 = 6.9% approximately.
So, 6.9% is the AROI. The results are expressed in percentage here as well.
Now that we know how to calculate the return on investment, let us take a look at what is a good return on investment.
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A Good Return On Investment
The goal of an investment is to get good returns. Even though the right investments reap good returns, determining which is the right one can be a challenge. Returns on investment vary depending on the type of investment, the timing, and the risk factors involved.
What is the best way to determine whether an investment results in a profit or a loss?
The Rule of 72
The rule of 72 is a shortcut method to calculate how long it will take for an investment to double at a fixed rate of return. Simply divide 72 by your expected interest rate to calculate your interest rate.
As an example, if you’re wondering how long it will take for your investment to double at 6 percent interest, you divide 6 by 72 and you get 12 years, which is how many years it will take for your investment to double.
Generally speaking, the Rule of 72 applies to compound interest rates and is mostly applicable for interest rates between 6% and 10%. You can apply the Rule of 72 to anything that increases exponentially, like GDP or inflation, and it can also indicate the long-term effect of annual fees on an investment’s growth.
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Investment Options For Investors
Taking the time to understand all your investment options before investing can help you make the right decision.
Low-risk investments: These investments are generally safe for investors and provide a guaranteed return. No matter what changes occur in the economy or business, investors would receive a fixed return on their investments.
Fixed deposits, securities, bonds, debentures, and government-run schemes such as NSC, PPF, EPF, etc are low-risk investments.
Medium-risk investments: Even though medium-risk investments carry a certain amount of risk, they provide high returns. Risk-taking investors who seek good returns can consider investing in debt funds, balanced mutual funds, and index funds.
Since market fluctuations may affect the returns, investors are not guaranteed fixed returns.
High-risk investments: These investments can offer great returns, but also present increased risks. Direct equity investments, equity mutual funds, or derivatives based on the underlying performance of assets fall under high-risk investments.
These investments are best suited for market-savvy investors who have a good understanding of the market’s performance and the risks involved.
Top Investment Options For Best ROI
Investment options can be bifurcated into two classes: financial and non-financial. Mutual funds, livestock, fixed deposits, recurring deposits, public provident funds are examples of financial assets. The non-financial assets include gold, real estate, treasury bills, etc.
Best Financial Assets That Reap Good Returns
1.Direct Equity Investment:
This refers to purchasing stock or shares of a company directly. This will usually require opening a demat account and trading account and investing through a stockbroker.
Because stocks are volatile, their returns are uncertain and they come with risks. Nonetheless, stocks yield higher returns in the long run, compared to other types of investments. Direct equity investment requires knowledge of the stock market, making decisions about which stocks to invest in, and knowing when to buy and sell the stocks.
Investment pundits agree that mutual funds are a popular investment choice because they provide many benefits. A mutual fund is a pool of money held by multiple investors. The portion of a fund that is owned by an investor is called a unit, therefore investors are often referred to as unitholders.
Unlike direct equity investments, mutual fund investments do not require the opening of a demat account. Investments in mutual funds can also be made in lump-sum amounts or spread over time with a SIP (Systematic Investment Plan) starting at just Rs. 500. SIP lets you invest a small amount in your preferred mutual fund scheme regularly. Investments through SIPs force you to put aside money each month, making managing your finances easier.
Mutual funds can be classified as either equity funds or debt funds. While equity funds are investments in equity shares and related securities, debt funds are investments in fixed income securities like government securities, corporate debts, and so on.
Equity funds are suitable for investing long-term and debt funds for short- to medium-term goals. Compared with equity funds, debt funds offer relatively low returns but are generally less risky.
Also called Government of India Savings (Taxable) Bonds, these bonds are issued by the Reserve Bank of India at 7.15 percent (compounded, payable every half year). The RBI Bonds have a floating rate of interest that changes every six months. Interest rates for the half-year ending December 31, 2021, and payable on January 1, 2022, remain at 7.15%.
Keep in mind the following while purchasing RBI bonds:
- RBI Bonds are taxed under the 1961 Income Tax Act
- Bonds are valid for 7 years from the date of issuance
- Anyone can invest in this bond, and the investment amount is not capped
- A premature withdrawal option is provided with this bond for senior citizens who meet certain requirements
- The bonds are not transferable, but there are nomination options available
- The minimum investment is Rs.1000/- and in multiples thereof
RBI bonds are available at some designated SBI branches, nationalized banks, four private sector banks, and the Stock Holding Corporation of India. The RBI bonds may be the right choice for you if you are considering guaranteed income on your investment.
4.National Pension Scheme (NPS):
Regulated by the Pension Fund Regulatory and Development Authority of India (PFRDA), NPS is a voluntary pension plan that is open to all citizens, though private-sector employees are encouraged to contribute regularly to their pension account during their service. Any private-sector worker who needs a regular pension after retirement can benefit greatly from the low-risk NPS scheme.
The following are some features and advantages of NPS:
- There are two primary types of NPS accounts, Tier I and Tier II, while the Tier I accounts are default accounts, Tier II accounts are voluntary
- Investors can make contributions at any point during the fiscal year and can choose how much to set aside each year
- NPS offers tax incentives under Sections 80C and 80CCD
- NPS funds cannot be withdrawn in full after retirement. You are required to save at least 40% of your corpus with a PFRDA-registered insurer, to receive pensions regularly
- Investing regularly until you reach 60 is the key, and if you have invested for at least three years, you are allowed to withdraw up to 25% to meet personal expenses
- You are allowed to withdraw up to three times in one term, with a five-year gap between the withdrawals. These restrictions are applicable for tier I accounts only
- If you are not satisfied with the performance of an NPS pension scheme or fund manager, you can change them. Tier I and tier II users can both take advantage of this benefit
- When you contribute to NPS, you will be investing a portion in equities, which provide higher returns than PPF or any other investment option
Visit National Pension System Trust to open an eNPS account online or visit any Point of Presence (POP), such as your bank.
5.Public Provident Fund (PPF):
One product that a lot of people turn to when they want to save on taxes is the PPF. Two factors explain its popularity: tax-free yearly interest and compounding annual interest.
- This fund has a lock-in period of 15 years, and the compounding interest has a major impact on returns, especially in the later years
- The lock-in period can be extended to another 5 years with or without deposits
- You can withdraw funds partially, once a year during the extended period
- You can obtain a loan based on your investment amount
- The government reviews and determines the interest rate on PPF every quarter
- A PPF account can be kept active with a minimum deposit of Rs 500, and a maximum deposit of Rs 1.5 lakh in a single fiscal year
- PPF investments are eligible for a deduction under section 80C of the IT Act
PPF accounts can be opened at banks or post offices.
Bank fixed deposits are another reliable investment option offering good returns. True to their name, these deposits offer fixed returns over the life span of the investment.
- Fixed deposits can be held for a minimum of seven days or a maximum of ten years
- The minimum deposit amount is Rs.50, although this amount varies with banks
- Regular account holders can earn up to 6.50% interest per year while senior citizens can earn over 7%
- The interests can be earned on a monthly, quarterly, half-yearly, yearly, or a cumulative basis
- Fixed deposits have a greater level of financial stability because they are not subject to market fluctuations
You can open fixed deposit accounts online or in person at your local bank.
Non-Financial Assets With Good ROI
When it comes to non-financial assets that yield good returns, real estate, and gold top the list.
Real Estate: Buying a piece of land or an apartment to stay or rent out is one of the best investment options existing in the country. Purchasing a property entails some level of risk, but it is less compared to other investment methods.
The returns from real estate investment are largely based on the size, condition, and general value of the property. This is one of the best investment options over the long run because it generates high returns.
Obtaining regulatory approvals and completing the paperwork can be quite a hassle, and unlike most other asset classes, real estate cannot be easily converted into cash, making it highly illiquid.
Gold: Gold is a symbol of wealth and prosperity and is one of the best non-financial assets you can consider investing in. Gold prices along with making charges make it an expensive investment.
For those who want to avoid paying the making charges for gold jewelry, gold coins are a great alternative, which banks sell these days. Yet another option of owning gold is in the form of gold papers.
Gold ETFs offer the opportunity to invest in paper gold at a lower cost. Gold ETFs, also known as Gold Exchange Traded Funds are a combination of gold and stocks that can be purchased and sold on NSE or BSE stock exchanges.
Another way to own paper gold is by purchasing sovereign gold bonds that are issued by the Government of India. These bonds offer both capital appreciation and annual interest and are a good alternative to physical gold. The bonds must be purchased with cash and are redeemable in cash on maturity. Check the Reserve Bank of India site to learn more about purchasing sovereign gold bonds.
The post office monthly savings scheme, the recurring deposits, initial public offerings, are additional investment options to consider in addition to those mentioned above. There are also investment schemes geared toward senior citizens, including the Pradhan Mantri Vaya Vandana Yojana (PMVVY) and the Senior Citizens Savings Scheme.
When it comes to financing, numbers are more important than anything else. So, plan your investments wisely to get maximum returns on your investments. Return on investment is not only confined to the financial sector; it also applies to many other spheres of life.