Return on Investment Expresses How Much Your Investment Grows!

Return on Investment (ROI) is an important financial term used throughout the investment world that explains how much your investment grows, why it grows, and how you can use debt to make money instead of using your own money to improve ROI percentages. Understanding ROI is one of the most essential things to learn when dealing with money. Spending less out of pocket (at first) and making more in return is what ROI is all about.

Return on Investment is defined by Dictionary.com as the amount of profit, before tax and after depreciation, from an investment made, usually expressed as a percentage of the original total cost invested. In other words, the profits you make from your investment are calculated as a percentage of how much you invested.

There is two primary ways to invest: With your own personal money or with other people's money (OPM). Borrowed money is deferred money and can foster amazing ROI results if you use it wisely. You don’t have to have the actual investment amount right away, so it gives you the leverage you need to make a larger purchase that you wouldn’t have been able to do with cash.

The leverage factor, the ability to make a purchase with other people's money, is why so many people borrow so much money, though most people who borrow have no idea they are using the leverage in a negative way (as with purchasing a vehicle or a personal home which can quickly become a liability with depreciation).

As you will see, borrowing the money as an Investment isn’t really as bad as most people think. It is also how financially smart people make significant return on investment with their money and keep building it long after they retire. You don't necessarily have to have money to make money, contrary to belief. You just have to be smart with your money and how you borrow money.

In the following examples, I'm not saying that paying cash for a car is the way to go, nor am I saying the borrowing money to buy a car is the smart thing to do. The following are just examples to help you understand the concept of ROI. Please read my terms of service to fully understand my disclaimer. Examples are only to show you how return on investment works, not giving you financial advice with how to invest.

This is where most people get lost, so pay attention closely. It's simple math, but it can be a very confusing topic.

Example 1 – No Leverage Applied:

Jodie buys a car for $1,000 with her own money, paying cash. She waits a year and sells the car for $1,200, essentially making $200 profit on her investment. Her ROI is 20 percent. It is pretty simple math (200 divided by 1,000 = .20). And most people are satisfied with the 20 percent return because they didn't have to go into debt to do it. The only problem with this is that your $1,000 investment isn't working as hard for you as it would if you didn't pay cash.

Example 2 –Leverage of Borrowing Applied:

Jodie buys a car for $1,000. This time she only pays $100 down payment with her own money and borrows $900 at 10 percent interest. Again, she sells the car at the end of the year for $1,200. How did she do this time? We have the same $200 profit. But now her personal investment is only $100 plus interest and cash she paid on the vehicle for the year. Interest and payment for her loan paid every month is $0.90 plus $75.00. She pays a total of $910.80 throughout the year to pay off the loan. All in all, she paid $1,010.80 for the car by borrowing the money to make the purchase. Her profit from the purchase is $189.20. Her return on investment is a little lower at 18.7 percent.

Remember, borrowed money is not yours to begin with. You have to pay it off so anything you pay back to the loan is part of your personal investment. If you don’t have enough to pay for something, you use other people’s money to pay for it then pay them back over time. It gives you the leverage to get what you want with less upfront money out of pocket. That doesn't mean go out and buy a car with other people's money right now. This is just a simplified example so you will understand the concept.

In the example above, borrowing money wasn't exactly the best idea for Jodie as she made less profit on the car, but she did use leverage to her advantage and made a profit. Most people that make a purchase with leverage, then sell the item later on down the road usually lose money because of high interest payments and selling the item for less that it was purchased for.

Now, put things in a more realistic perspective and learn how return on investment can make you more money.

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