The whole idea behind investing is to make money. Whether we’re talking about the stock market, real estate, or anything else that can be bought and sold, what matters most is the return on an investment (ROI). Let’s say you have an asset that’s increased in value since you bought it. If you turn around and sell it now, you’ll net a positive return if the profit outweighs your tax liability. Or you could be left with a negative return, meaning you lost money.
But, what is a good return on investment? The answer isn’t so simple. It all depends on the type of asset and your investment goals. Understanding how it works can help you determine what makes a good ROI.
ROI, which is shorthand for return on investment, is usually expressed as a percentage. It represents your net profit or loss and communicates how well an investment performed. If you bought a house for $400,000 and sold it for $600,000, that’s a $200,000 gain. After deducting realtor fees, closing costs, and other expenses, what you’re left with is your net profit. This number can be positive or negative.
You can calculate the ROI on current investments and also estimate the ROI on potential investments. Just remember that it's impossible to predict with 100% accuracy how an investment will perform. That’s why diversifying your portfolio is so important. This involves holding a mix of high- and low-risk securities across different sectors and industries. That way if one area loses value, it won’t be enough to tank your portfolio. It’s a simple way to mitigate investment risk.
To calculate the return on an investment, you’ll want to zero in on two important factors:
The price you paid for it
Its current value
The difference between these two numbers represents your net profit. This number will hopefully be positive. Again, ROI is expressed as a percentage. To get there, simply divide your net profit by your initial cost, then multiply that number by 100. Let’s say your net profit after selling your home is $100,000. If you originally bought it for $400,000, your ROI is 25%.
You can also calculate the ROI on stock investments, which can be positive or negative. Let’s say you bought 100 shares of stock for $15 each. Your initial investment is $1,500. If those shares are now worth $10 per share, the current value of your investment is $1,000. Your net profit is -$500. That’s an ROI of -33%. In other words, if you sell now, you’ll lose over a third of your initial investment.
The answer isn’t so black and white. Expenses associated with your investments come into play. Buying and flipping real estate properties is a good example. You may capture a net profit when you sell a property, but you’ll also need to factor in any additional money you put into it. That might be renovation expenses, listing fees, and more. When stock trading, your expenses may include broker fees and capital gains tax.
There may also be non-financial factors that determine your total ROI. If you’re fixing and flipping real estate, that may be the time and energy you spend finding and renovating properties. Positive returns may not be worth it if these projects cause you stress.
When you net a profit on a taxable investment or asset, that’s called a capital gain — and you’ll likely owe taxes on it. The amount you owe depends on:
How much you sold it for
The amount you originally paid
How long you owned it
Your income and tax-filing status
Capital gains tax generally applies to investments like stocks, bonds, mutual funds, and real estate. You won’t have to pay taxes until you sell the asset and realize gains and certain tax-advantaged accounts don't have capital gains taxes. Just know that investments held for over a year are taxed as long-term capital gains, which have a more favorable tax rate. Short-term capital gains, on the other hand, are taxed as ordinary income.
Investment losses aren’t ideal, but you can use them to offset capital gains. If you have gains and losses, the difference between the two represents your net capital gain — and you’ll only pay taxes on that.
When determining what is a good return on investment, it’s important to remember that benchmarks are different from asset to asset. Below is a breakdown of average returns over the last decade, according to a 2022 Bankrate analysis:
Real estate: 8.8%
1-year CDs: 0.38%
More speculative assets, like cryptocurrency, tend to have wilder returns. Let’s say you bought a single Bitcoin in January 2019 for $3,823, then sold it in November 2021 — when its value had skyrocketed to $65,496. That’s a net profit of over $61,600. The return on investment here is more than 1,600%. But hardcore negative returns are also possible. By November 2022, Bitcoin’s value had plummeted by 75%. Investing in Bitcoin futures through a Bitcoin-linked ETF allows you to have exposure to the coin without buying on an unregulated market. Instead of investing directly in Bitcoin, you’re putting a portion of your investment portfolio toward its potential value.
Stocks are also considered high-risk assets, though they aren't typically as volatile as cryptocurrency. Investing in exchange-traded funds (ETFs), mutual funds, and index funds (as opposed to individual stock picking) allows you to spread out the risk. It also helps diversify your portfolio, which is a time-tested principal of investing. Acorns Later will also recommend a portfolio of ETFs for you based on your risk tolerance.
There are several ways to measure the ROI of the stock market. Let’s start with the big picture. From 1950 to 2022, the average annualized return on the S&P 500 was just over 11%, according to J.P. Morgan. Meanwhile, bonds returned 5.5%. It’s worth noting, however, that asset allocation plays a big role here. A portfolio consisting of 50% stocks/50% bonds would have returned 8.7% during this period of time.
The more you’re invested in stocks and other high-risk assets, the more aggressive your portfolio is considered. Stocks are more volatile than bonds, but they typically allow investors to net greater returns over the long haul. Market swings along the way are part of the ride. Most financial advisors suggest dialing back on risk as you get closer to retirement and have less time to recover from bouts of market volatility.
What should your asset allocation look like as you age? The Rule of 100 offers one approach. It has you subtract your age from 100. The resulting number is the percentage of your portfolio to devote to stocks. Following this rule, a 40-year-old investor would have a portfolio made up of 60% stocks/40% bonds. For close to a century, this type of portfolio has had an average annualized return of 8.8%, according to The Vanguard Group.
So what is a good return on investment? It really depends on what you’re investing in. As a general rule, riskier assets have the potential for greater returns. Crypto, individual stocks, private equity, and hedge funds are great examples. Investors can either score big or lose a lot of money.
Meanwhile, investments like bonds, certificates of deposit (CDs), and money market accounts are considered low-risk investments. They generally don’t offer super high returns, but they can provide some stability in an investor’s portfolio. They’re seen as safe, consistent investments.
The goal is to build your portfolio based on your risk tolerance, but remember, risk is often necessary to grow your wealth over the long haul, keep up with inflation, and prepare your nest egg for retirement — but being too aggressive with your investments could lead to serious losses. It’s a balancing act.
The bottom line is that a good return on investment means coming out ahead. How you measure that is up to you.
This material has been presented for informational purposes only. The content is generalized and may not be appropriate for all investors. The information contained in this article should not be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product. Past performance is no guarantee of future results. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions. No level of diversification or asset allocation can ensure profits or guarantee against losses.