When investing in cryptocurrencies or other markets, the end goal is to achieve a return on investment (ROI). That is often much easier said than done, as several factors are worth paying attention to. Calculating one’s ROI is a lot more complicated than you may assume.
A Return On Investment Is Crucial
Investing is a challenging but potentially rewarding strategy. No one wants to lose money, but rather increase their portfolio’s value. Doing so requires ways to acquire a return on investment, either in the short or long term, and to calculate that ROI is a crucial first step.
A Tool For Everyone
Calculating the potential ROI on an investment is not overly complicated, but it is not a matter of subtracting two values either. For many people, it is a matter of taking the sale price, subtracting their initial buy price, and regard the result as the ROI. That formula works in a perfect world, but that world does not exist today, unfortunately.
Most traders are interested in calculating their return on investment to determine how successful their trading strategy is. Before that can happen, however, one needs to make sure the calculation’s formula is accurate. There is no reason to trick one’s brain into thinking you performed better or worse than the numbers say.
It is also worth noting that calculating an ROI does not just apply to trading or investing. It can be used for any purchase made in life.
For example, if you buy a new video game, and it costs $60, what would be a good ROI? Is it the amount of fun you had? The number of hours played until completion? Does it have replay value? Did you get $60 worth of entertainment, or more, or less? Similar to investing and trading, there are different methods to determine what ROI means for you.
The Simple (Albeit Incorrect) Value
The easiest way to determine an ROI is by using the most straightforward values. As noted above, take the current sale price and subtract the original investment cost. Then, divide that outcome by the initial cost again.
In this example, we will look at Bitcoin, purchased at $20,000, and currently valued at $41,000.
ROI = (41.000 – 20,000) / 20,000 = 1.05. In dollar value, our investment returned a profit of $21,000.
An ROI of 1.05 is very positive, as it shows you have effectively doubled your value through this bitcoin investment and added an extra 5% on top.
To put the ROI into a percentage, multiply by 100. in this case, your return on investment is 105%. Performing this process gives you the rate of return or ROR.
It is hard to come by outcomes above 1, but they can materialize depending on one’s investment strategy.
Subtracting The Expenses
Many traders overlook how any fees and initial expenses need to be deducted from the ROI calculation.
First up, we start by extracting the initial expenses involved in this particular trade.
In the case of our Bitcoin investment, there are no initial expenses or “maintenance fees” to speak of. However, some platforms may charge a fee for keeping your position open. Such costs can occur when dealing with investment vehicles such as futures and derivatives. Holding one’s long or short position open for weeks or months will incur extra maintenance fees traders need to be aware of.
Don’t Forget The Fees
Secondly, there are the regular trading fees found on nearly any platform.
On exchanges and trading platforms, there is often a maker and taker fee. More specifically, users pay to place buy orders and to sell their assets afterward. These costs reduce the overall ROI of an investment slightly.
Assuming the exchange charges a 0.1% maker and taker fee, those need to be taken into account for the calculation.
One fee of 0.1% is placed when we buy Bitcoin. As we purchased $20,000 in BTC, our cost equates to $20, which also means we effectively receive $19,980 in BTC and not $20,000.
The second fee of 00.1% applies when we sell BTC at $41,000. In this case, that is a $41 cost, ensuring we do not receive the full $41,000 but $40,959 instead.
The Right ROI Calculation
Our new ROI calculation then becomes:
ROI = (40,959 – 19,980) / 19.980 = 1.05
While this outcome is the same – thanks to the identical maker and taker fees – the dollar value is not the same. We initially assumed the profit was $21,000, but in reality, it is $20,979. Not a humongous difference, but these small discrepancies can add up over time.
An Imperfect Way Of Thinking
Even with the above knowledge in mind, calculating a return on investment has no perfect “formula”. It only takes a few factors and numbers into account. However, trading and investing are about more than just buying, selling, and deducting costs.
There is also the aspect of “time”. More specifically, one may achieve an ROI of 1.05, but it took them ten years to do so. Does this make the investment worthwhile? For some, it may, whereas others prefer shorter investment periods.
Additionally, one has to wonder if a high ROI automatically makes the investment worthwhile. Making money is great and exciting, but the result has to justify the means. All investors and traders have different opinions in this regard.
Another aspect to take into account is the overall risk. Investing in Bitcoin is risky due to its volatility. The price can always go lower than what you originally paid, even though it has a strong chance of rising in value over time. One’s return on investment formula doesn’t take risk into account, yet traders can’t overlook that aspect.
Calculating a return on investment is a crucial aspect of any trading or investment strategy. Doing so correctly is paramount, even if the overall monetary difference may seem minimal.
That said, ROI is not an exclusive or ultimate metric to look into either. It is merely another tool in the belt to becoming a successful trader.
The end goal of trading or investing is to feel comfortable while doing so. Whether that yields a small, big, or negative ROI, is irrelevant, for the most part. No one needs to force themselves into doing something they dislike, even if the potential return on investment can be massive. You do you, regardless of what other traders may try to talk you into.