Good investments maximize your hard work and frugal lifestyle by allowing your savings to grow. That sounds great, but knowing if your investment is sound takes a little work. This is particularly true when the calculation involves recurring expenses that continually increase your investment. Because of its simplicity, calculating the return on investment, or ROI, is a popular choice for assessing an investment. When using this approach, you need only total these recurring expenses.
Total Recurring Expenses
Recurring expenses include any costs you incur on a regular basis. As an example, you may need to pay a monthly mortgage and regime fee on a rental property. Totaling these monthly expenses avoids calculating multiple expenses. Armed with a monthly total, you can multiply by 12 to find your total annual expenses, and then multiply by the total investment period to calculate the total recurring expenses. As an example, a $500 mortgage and a $100 regime fee total $600 per month. Multiplying by 12 calculates an annual expense of $7,200. If you sold the property five years later, the total expenses would be $36,000, calculated as 5 times $7,200.
Adding Other Expenses
You may have incurred expenses other than recurring ones. To calculate ROI, you need to total all these expenses, including the total recurring expenses. Extending the example, imagine you put $20,000 down for purchasing a property and you paid a contractor $10,000 for repairs. When you ultimately sold the property, you had to pay off the remaining mortgage of $120,000 and pay closing costs of $5,000. Adding all these figures, including recurring expenses, yields a total of $191,000.
Calculating Recurring Income
The flip side of recurring expenses is recurring income. If your investments regularly earn income, this cash-flow can offset your expenses. If the example real estate property generated rental income of $700 per month, multiplying $700 by 12 gives you an annual income of $8,400. If this was maintained for the entire five years you owned the property, multiply that figure by 5 to calculate total income of $42,000.
Profit is what's left over after you subtract expenses. To calculate profit, simply take your total income and subtract total expenses. If you gained a lump-sum payment at the end of your investment, remember to include that in your total income. In the example, if you sold the property for $200,000, add that to the $42,000 total recurring income to get $242,000. Subtracting the total expenses of $191,000 leaves you with $51,000.
Return on Investment
ROI is simply your total profit divided by your total expenses. Multiplying the resulting figure by 100 converts it into percentage format. In the example, dividing $51,000 by $191,000 calculates an ROI of 0.267. Multiplying by 100 converts this to 26.7 percent.
Net Present Value
An alternative method of calculating ROI uses net present value, or NPV. This method discounts expenses and income with respect to time. The theory holds that money in the future is worth less than money today, so any recurring expense or income needs to be discounted to accommodate inflation or alternative investments. The reason alternative investments are used is that money invested in the current venture cannot be invested in the alternative one; therefore, you miss this opportunity. Once each expense and income payment is discounted, ROI is calculated the same way using the discounted figures.
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