What is Return on Investment for Stock Market Investing

Return on Investment (ROI) is an important term used throughout the financial community. Understanding how to maximize your ROI is even more important. Spending less out of pocket (at first) and making more in return is what ROI is all about.

When investing your own money in the stock market, you want to gain as much profit as possible, but all of your own money is doing the work. As long as all of the dollars you have invested are making money, all is good.

ROI can greatly improve if you use OPM (other people's money) along with your money on the same trade, also known as trading leverage. There is more risk involved with "borrowing" money to invest, but the rewards can be pretty sweet.

Borrowed money is deferred money. You don’t have to use it right away, but it gives you the leverage to purchase more shares of stock than you can buy with your own personal investment.

As you can start to see, borrowing money isn’t really as bad as most people think it is, as long as you know what you're doing and you have a better than average chance at success with the trade. This is also how financially smart people make even more money in their portfolios and keep building it long after they retire.

The Simple Formula for Return on Investment

The formula for return on investment is as follows:

ROI = Profit / Personal Investment (the resulting ROI is a percentage)

Simple equation, right? Well, first you have to know how to come up with your number for profit. And you must know the number for your personal investment. Each take a little more math to complicate things a little more.

Let's work backwards since it's easier to start where you begin. Personal investment is the dollar amount of money you personally put into the stock. When dividends are added to your stock via reinvestment, these don't count for the personal investment part. But they do improve profit. It's the money that you personally invested.

Profit = (Total Shares Owned x Price per Share)-(Total Shares Owned x Cost Per Share)

Now, in order to continue calculating a return on investment, we need to know what number to use for personal investment.

The personal investment in the ROI Formula is how much of your own personal money was used for investing. This will not include any fees associated with the purchase. If you invested $1,000.00 and it cost you $9.96 for the buy and sell fees, you still only invested $1,000.00.

Simple, right?

Now that you know how to get all of your numbers, let's throw a couple of examples together to see how it all comes together to calculate a return on investment percentage.

Example 1 - No Margin Investment

In the following ROI example, you are only investing your own money and not using any margin funds for leverage.

Shares Owned = 100
Buy/Sell Fees = 9.96
Original Price per share = $10.00
Personal Investment = $1,000.00
Total Cost per Share = $10.0996
Current Price per Share = $13.55

Profit = (Total Shares Owned x Price per Share)-(Total Shares Owned x Cost Per Share)
Profit = (100 x 13.55)-(100 x 10.0996)
Profit = 1355 - 1009.96
Profit = $345.04

ROI = Profit / Personal Investment
ROI = 345.04 / 1000.00
ROI = .34504 x 100
ROI = 34.504%

See, not too difficult. Simple math. This can be easily calculated on a Excel spreadsheet so all you have to do is plug in a few numbers and the ROI will be calculated for you.

Example 2 - With Cash and Margin Investment

Now let's plug in some margin numbers into the return on investment formula so you will see the importance of using a margin account to your advantage.

Shares Owned = 200 (you own more shares for the same $1,000.00 invested)
Buy/Sell Fees = 9.96
Original Price per share = $10.00
Personal Investment = $1,000.00
Margin Investment = $1,000.00 (doesn't figure into the cost)
Total Cost per Share = $5.0498 (this is where the big difference is)
Current Price per Share = $13.55

Profit = (Total Shares Owned x Price per Share)-(Total Shares Owned x Cost Per Share)
Profit = (200 x 13.55)-(100 x 10.0996)-(1000)
Profit = 2710 - 1009.96 - 1000
Profit = $700.04

ROI = Profit / Personal Investment
ROI = 700.04 / 1000.00
ROI = .70 x 100
ROI = 70.0%

It's amazing how much more return you can make on your investment when use your own cash and a little margin leverage for the trade.

Margins can be a wonderful thing when determining return on investment, but they also are risky. If the price of the stock drops below the cost, you will have to pay back the margin account out of your own money. Fortunately, the total cost per share drops significantly when you double your shares with a margin and you have more room to experience the loss and get out before it's too late.

I hope you see the point I'm trying to build in your mind. It is encouraged to utilize a margin to improve your return on investment, but be very careful as this can backfire and you will lose a lot more money if the trade goes sour.

Learn more about return on investment so you can fully grasp the concept of making more money with each dollar.