Home > Real Estate > Return On Investment vs. Return Of Investment

Return On Investment vs. Return Of Investment

by Andrew C. MacDonald on January 26, 2011

Sir Millard MulchWhen considering investments, most of us consider the Return On Investment (ROI) when evaluating our options, but we may forget to consider an even more important metric – Return Of Investment.

First and foremost, the return of your invested capital is the most important consideration when making an investment. For the purpose of this article I am talking about investing rather than speculating, although the same rules still apply. With speculation, there is a greater risk of loss, but greater upside potential to go along with it. Assuming our primary goal is building long-term wealth, we want to ensure our principal is safe as we put it to work to earn a return.

An Investment Gone Wrong

Nobody likes to think they’ll be the one to fall victim to a con, but most of us have been taken advantage of in some way or seen some type of agreement go sour in our lifetimes.

As a simple example, consider the smooth talking salesman driving a flashy car and sporting Prada pants. While that person may have the outer trappings of affluence and appear to know what they are doing, they may just as well be the next Bernie Madoff luring you into their scheme. Let’s say we loan $50,000 on a deal with our slick new friend and are to earn a fixed 10% return for a 5 year term. Our new investor pal can use the first $25,000 to make our interest payments for 5 years, and then use the other $25,000 to go on a lavish vacation. In this case we’ll be 5 years older and $25,000 poorer by the time we figure out the investment is bogus, not to mention the stress that will come along with trying to recover our loss later on.

5 Rules to Ensure Return Of Investment

Here are 5 quick rules to ensure you get both a return of your investment, and a return on your investment.

  1. Only invest with those you trust
    If there were only one rule, this would be it. Ensure you invest only with people of character, people who honour their word, and people who will treat your money like it is their own.
  2. Understand the investment
    Before making any investment, make sure you understand how it works. Most sound investments can be explained within 30 seconds. If it takes any longer than 30 seconds to explain, be wary.
  3. Understand the risk/reward relationship
    In the world of money, reward is commensurate with risk. If someone is offering an exorbitant return, do you understand the exorbitant risks to go along with it? Keep in mind here that if something sounds too good to be true, it probably is.
  4. Do your due diligence
    No matter who you are dealing with, be sure to complete your due diligence on both the partner and the deal itself. Verify the facts involved, ask the tough questions, and be sure everything meets your standards before handing over a cheque.
  5. Get references
    Before investing with someone, ask for at least 3 references who have invested or done business with them in the past. If someone cannot provide you with 3 positive business references, they are probably lacking the standards or track record you’re looking for in an investment partner.

Follow Your Sixth Sense

By following the 5 rules above, your sixth sense will let you know whether its time to invest, or not. If the deal passes your “gut check”, go ahead and put your money to work. On the other hand, if you’re still skirmish, ask some more questions, get the clarification you need, or simply pass on the deal knowing another opportunity will present itself shortly.

Creative Commons License photo credit: rick

If you enjoyed this post, get free updates by email or RSS.

{ 6 comments… read them below or add one }

Beverly Frosch February 2, 2011 at 11:01 am

Well spoken, so many people fail because they don’t do their due diligence!

Robin August 4, 2012 at 4:57 am

Thank you for a fruitful article but I would like to ask you more academic question being still confused with return on investment vs. retun of investment terminology. To illustrate and to get better understanding, I would like you help me to answer the following question. Let’s say Company A sonsiders a capital project that will return $100,000 each year for 5 years. At the company’s hurdle rate of 10%, the present value of the annuity is $379,100. Here is the question: if the return on investment in the first year is $379,100, what is the retun of investment that year? Thanks a lot for your clarification. Regards. Robin

Andrew C. MacDonald August 8, 2012 at 11:52 am

Hi Robin,

The Return OF Investment simply refers to getting your original investment back. The Return ON Investment is the profit you are making on that original investment.

Cheers,
Andrew

Robin August 10, 2012 at 3:11 am

Dear Andrew,

Thank you so much for your clarification and response.

In this case, return of investment should be $100,000, i.e. getting the original investment back, Is it correct?

Thanks a lot again and Best Regards,
Robin

Andrew C. MacDonald August 13, 2012 at 12:29 pm

Hi Robin,

Sure, you could look at the $100,000 in the first year as a return OF your investment. Then, once you’ve recovered your initial investment, you can consider anything extra to be return ON investment.

The simple point of my post was to make sure you are choosing investments where you can be sure of a return OF your investment, and not be blinded by promises of a great return ON your investment.

Cheers,
Andrew

Robin August 17, 2012 at 5:54 am

Dear Andrew,

Million thanks indeed for your further elaboration and clarification – well noted and appreciated.

You cannot be more helpful and pleasant and my Best Wishes.

Warm Regards,
Robin

Leave a Comment

Previous post:

Next post: