Back to the Basics: What's the difference between ROI, APR and APY on your investments?

Maybe we picked up too much speed lately. We're talking about different blockchains, bridging, defi, wrapping and unwrapping, liquidity pools, impermanent loss, multipliers, yield farming and harvesting or compounding inflation in dens. Just from the top of my mind some of the hottest topics lately.

Got everything already? Ok, let's move on!

Nah, let's slow down for a change in this post.

I'm not going to talk about any of the topics above.

But maybe today's topic will be interesting as well.

Let's begin!

^Source

Do you know what ROI, APR and APY are and how are they different, without looking them up?

Have you ever mixed them up? I admit I did. I used to mix up APR and APY without understanding the differences, because I was never curious to learn about them. Since I'm not living in an English-speaking country as an official language, these terms don't come with my life experience, as they have different names in our native language.

Let's talk a little more about each of them.

ROI (Return on Investment)

Return on Investment is defined through its simple formula:
profit earned divided by cost of investment

So, if you bought 1000 Hive at 15 cents, the cost of investment is $150.

If you want to calculate the ROI at 45 cents per Hive, you do it like that:

ROI = (45 - 15) * 1000 / 150 * 100% => ROI = 200%

Pretty impressive ROI, huh?

The advantage of ROI is its simplicity. Anyone can calculate it, even by hand, as you could see in the example above.

The drawbacks of ROI are:

• you cannot compare two investments over different time periods based on their ROI (example why not: suppose you were trying to compare two investments, one that had a 5 percent return over 1 month versus another that had a 50 percent return over 1 year. Which one is better?)
• you cannot calculate ROI accurately if investment was made in increments. Suppose you invested $100 monthly for one year and ended up with $1,300. What would your investment return have been over that time period?

For handling both the above shortcomings of ROI better suited is APY.

Annual Percentage Rate (APR) vs. Annual Percentage Yield (APY)

What is the APR? The annual percentage rate measures the amount of interest an investment earns over the course of a year.

What is the APY? The annual percentage yield (or simply, yield) is the rate of return that an investment provides when compared to your initial investment, taking into account compound interest.

I chose not to include the formulas for APR and APY in this post, because they are not relevant unless you want to go into details, but you can find both of them in the sources listed at the bottom.

As a terminology, you earn a yield on your investments, and you pay a rate on your loans.

APY is different from APR in two ways:

• the most significant: yield takes into account compound interest, rate doesn't
• the more frequent or the higher the interest rate, the higher the difference between APY and APR

Because APY is generally higher than APR, investment companies usually advertise APY while lenders promote APR.

Final words

I hope these terms are clear to you. Personally, I'm glad I sorted out the differences between APR and APY for myself and made the right connections to the terminology we use in our language, because we certainly don't use these abbreviations.

Sources:
https://mindyourdecisions.com/blog/2008/11/13/calculating-the-rate-of-return-on-investments-roi-versus-irr/
https://www.investopedia.com/personal-finance/apr-apy-bank-hopes-cant-tell-difference/
https://finance.zacks.com/formula-calculating-apy-bonds-3587.html
https://finance.zacks.com/calculate-apy-investment-10497.html

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