What is the difference between Rate of Return and Return on Investment?

Question

Investopedia's Return on Investment (ROI) page says:

ROI can be used in conjunction with Rate of Return, which takes in account a project’s time frame

From this I understood that Return on Investment and Rate of Return are different formulas. They are two different measures. But in the Rate of Return (RoR) page, it says:

This simple rate of return is sometimes called the basic growth rate, or alternatively, return on investment, or ROI.

The second quote I have given from Investopedia ROR page contradicts the first quote from the ROI page. Moreover, the word "return on investment" is linked to the ROI page mentioned in the first line.

I am confused. Can anybody confirm that both are the same? If not, what are the formulas for these two measures and the differences between them?

Answer 1

ROI (Return on Investment) is a simple percentage.

https://investinganswers.com/financial-dictionary/technical-analysis/return-investment-roi-1100

The return on investment formula is:

ROI = (Net Profit / Cost of Investment) x 100

But the word "rate" in ROR (Rate of Return) means that it involves time.

https://investinganswers.com/financial-dictionary/investing/rate-return-5875

Compounded annual growth rate (CAGR) is a common rate of return measure that represents the annual growth rate of an investment for a specific period of time.

The formula for CAGR is:

CAGR   =   (EV/BV)^(1/n) - 1

where:
EV = The investment's ending value
BV = The investment's beginning value
n  = Years

For example, let's assume you invest $1,000 in the Company XYZ mutual fund, and over the next five years, the portfolio looks like this:

End of Year    Ending Value
1              $  750
2              $1,000
3              $3,000
4              $4,000
5              $5,000

Using this information and the formula above, we can calculate that the CAGR for the investment is:

CAGR = ($5,000/$1,000)^(1/5) - 1 = .37972 = 37.97%

The simple ROI on this investment would be:

(5000 - 750)/750 * 100 = 566.67%

Answer 2

Return on Investment is simply your profit as a percentage of what you put in. For instance, if you put in $100 and get $115 back, then you have $15 of profit, which is a ROI of 15%.

Rate of Return is the interest rate that an investment would have to pay to match the returns. In the previous example, if it took you two years to get your money back, then that's equivalent to an interest rate of 7.23%: with compounding over two years, an interest rate of 7.23% would give you 15% of the principal in interest.

If you get the return on the investment at a fixed time, the RoR is relatively simple to calculated; it's simply (1+RoI)^(1/n), where n is the number of years it takes to get your money back. But if you have a stream of payments at different times, then the calculation is more complicated. In fact, in some cases it's not uniquely defined.

Answer 3

This is an old question, but the answers are not accurate in my opinion.

Like many other terms in finance, these terms can be used interchangeably, and can mean different things in different contexts. Even the linked Investopedia page (which in my opinion in not to be considered authoritative) contradicts itself:

Return on investment (ROI) is calculated by dividing the profit earned on an investment by the cost of that investment.

Okay, seems simple enough. But...

ROI can be calculated over any period of time, but it's most commonly calculated on an annual basis

But the calculation you just gave does not take time period into account - so if it's commonly annualized why doesn't it include that in the formula?

ROI is typically just calculated as the percent "gain" over the initial investment and is often annualized to be more comparable - would you prefer to make a 20% return in one week or 5 years?

ROR is a more general term that can mean the exact same thing as ROI in some contexts, or it can mean a more complicated measure of "return" like IRR or CAGR. It, too, can be either the overall return or annualized for comparability, but there is no strict definition that requires it to be one or the other.

So if you're asked to define ROI or ROR, you can give one of these definitions but qualify that there is not one strict definition. Or, if you are given an ROI or ROR and want to compare it to something else, you need to make sure you know the way in which is was measured ad whether or not it's annualized.