Why Don’t People Think In Terms Of ROI?

2 December 2011 | talking about Leadership, Small Business

Something that bugs me is entrepreneurs who are starting a company or making an investment but do not think in terms of return on investment, or ROI. Simply put, ROI is an estimate: if you invest a dollar how much will that dollar grow to? Typically you calculate your ROI as a percentage. Lets say I invest a dollar today and 5 years from now that dollar is worth $1.20. That means you got a 20% return over 5 years (or 3.71% per year).

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Also, for the record this rant is not in relationship to the Mark Zuckerbergs, Bill Gates, or Steve Jobs of the world. These guys all started companies when they had no financial worries. The only risk was failing and going back to college. I am speaking the commoners, those who already have jobs. Those who already have a family. Those who already have a mortgage and a car payment. I am speaking to the people who buy rental properties, start web companies at night, or quit their job to go all in on a ice cream shop -not kids in dorm rooms (many of us missed that boat)

Why does this bother me so much? Most people start businesses or make investments to get richer. I realize by default we tend to gravitate towards businesses we are passionate about or investments that make sense to us. This, however, is not always the best investment. If the goal is to maximize wealth why not think in terms of ROI?

The example I love is real estate vs. the stock market. So many people love real estate. They say it is “their thing”. If you compare the ROI of a stock market (or even a REIT) investment to buying a rental property a lot of times you will find a higher ROI in the stock market. The way I see it, therefore, learning about all possible investments and using ROI as a major metric in your decision is the smarter way to go.

Another example. Being in the web world I have friends starting web companies almost every day. Some are trying to build a non-ventured backed company for the “long run”. Some have or are trying to raise venture capital so they can sell their company in the future. One model has a payout via dividends and the other has the payout at the end when the company sells. I think in many cases the ROI for these different models is almost the same (of course it depends on the numbers you hit). When I compare companies such as 37signals, Mailchimp, Freshbooks, and so on to companies like Mint, Outright, and inDinero I think the ROI over 10 years is much higher for the former group of companies than the ladder.

Of course ROI is not the only decision making metric. Still, I think it is pretty darn stupid if that is not a top metric when deciding on investment or businesses.

tags: roi, startups, investing, small bussiness, real estate, investment style

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