ROI vs CAGR vs Payback Period
ROI, CAGR, and payback period are three of the most common metrics used to evaluate investments. They measure different aspects of performance, and choosing the wrong one can lead to poor decisions.
Quick comparison
| Metric | What it measures | Time factor | Best for |
|---|---|---|---|
| ROI | Total return | Ignored | Simple comparisons |
| CAGR | Annualized return | Included | Long-term investments |
| Payback | Time to recover investment | Core metric | Risk / liquidity focus |
ROI (Return on Investment)
ROI measures the total return relative to the initial investment. It is simple and intuitive but does not account for time.
CAGR (Compound Annual Growth Rate)
CAGR shows the annual growth rate of an investment over time. It smooths volatility and enables better comparisons across time horizons.
Payback Period
Payback period measures how long it takes to recover the initial investment. It is often used to assess risk and liquidity rather than return.
When should you use each?
- Use ROI → when comparing simple outcomes
- Use CAGR → when comparing investments over time
- Use Payback → when evaluating risk and liquidity
Common mistake
Many investors compare ROI across different time periods without adjusting for time. This leads to misleading conclusions and poor investment decisions.