Adapting business tools to your home finances often helps take the emotion out of a decision so that you can make a logical choice.
The idea of “return on investment,” or ROI, is fairly simple.
A business investment should save or make money. The ROI calculation is an attempt to determine how much each dollar invested will return. If a business has limited resources, only the highest ROI projects would be financed. You can see how this concept could really help your home finances.
To calculate the ROI, you take the value of the benefits and divide by the value of the costs. When professionals use these tools, they often use complicated formulas that take into account that having $1 today is worth more than $1 you won’t get until next year.
Fortunately, in most home applications, that’s simply not necessary.
Compare the yellow energy-efficiency label from your 12-year-old refrigerator to one on a brand-new model.
- According to the labels, you should save $65 per year in electricity.
- The new refrigerator costs $449.
- If you use the new fridge for 12 years, you’ll save $780 ($65 times 12 years).
So, the ROI is 73%. This is because $780 minus $449 equals $331 and $331 divided by $449 equals 73%.
That’s interesting, but should you buy the fridge?
You might get a more useful answer by considering the payback period. If you save $65 per year and pay $449 for the refrigerator, it will take 6.9 years before you’ve recovered the cost of the fridge.
You figure this by dividing $449 by $65, which equals 6.9 years. So, unless you plan to use it for more than seven years, you should pass up the purchase.
Many spending decisions are hard to analyze. But you can use this same process to calculate whether it’s worthwhile buying compact fluorescent bulbs or a new furnace. By breaking a decision down into an ROI or payback type of calculation, you’ll have a framework for making good financial decisions.