Why is return on investment (ROI) a bad measure for calculating long-term investments?

By Jean Folger AAA
A:

ROI is a performance metric used to evaluate the financial efficiency of an investment, or to compare the relative efficiency of multiple investments. It measures an investment’s gain or loss relative to the initial investment. ROI is calculated as follows:

ROI = (earnings – cost of investment) / cost of investment * 100%

While ROI is often associated with purely financial investments – such as the purchase of stock shares or an investment in a mutual fund – ROI figures can be calculated for nearly any activity into which an investment has been made and an outcome can be measured. The outcome of a ROI calculation will vary depending on which figures are included as earnings and costs. The longer an investment horizon, the more challenging it may be to accurately project or determine earnings and costs and other factors such as the rate of inflation or the tax rate.  It can also be difficult to make accurate estimates when measuring the monetary value of the results and costs for project-based programs or processes (for example, calculating the ROI for a Human Resources department within an organization) or other activities which may be difficult to quantify in the near-term and especially so in the long-term as the activity or program evolves and factors change. Because of these challenges, ROI can be less meaningful for long-term investments.

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