Two investments can both return 40%, and yet one is far better than the other. The difference is time. Return on investment (ROI) tells you how much you gained in total, while compound annual growth rate (CAGR) tells you the equivalent steady yearly rate. Using the right measure helps you compare investments honestly.

What Is ROI?

ROI = (final value − initial investment + any income received) ÷ initial investment × 100. Suppose you invest 10,000 and sell for 14,000. Your ROI is (14,000 − 10,000) ÷ 10,000 = 40%. If you also received 600 in dividends along the way, the ROI is (14,000 + 600 − 10,000) ÷ 10,000 = 46%.

ROI is simple and works for stocks, property, a business project or a marketing campaign. Its weakness is that it ignores time: a 40% gain in one year is spectacular, while a 40% gain over ten years is ordinary.

What Is CAGR?

CAGR = (final value ÷ initial value)^(1 ÷ years) − 1. It answers the question: what constant annual rate would turn the starting amount into the ending amount?

  • If the 10,000 became 14,000 over 4 years, CAGR = 1.4^(1 ÷ 4) − 1 = 8.78% per year.
  • If it took 5 years, CAGR = 1.4^(1 ÷ 5) − 1 = 6.96% per year.
  • If it took 10 years, CAGR falls to about 3.4% per year.

The ROI is 40% in every case, but the quality of the result is very different. For more on the formula, see our guide to the power of compound interest.

ROI vs CAGR: Which Should You Use?

  • Use ROI to measure the total result of a single project or trade, especially for short periods, where annualising is not meaningful.
  • Use CAGR to compare investments held for different lengths of time, or to compare an investment with a benchmark such as an index or a savings rate.
  • Use both together: ROI shows the size of the outcome and CAGR shows its speed.

Smooth Growth Is an Illusion

CAGR assumes smooth growth, but real investments move up and down. A portfolio that gains 40% in year one and loses 20% in year two ends up with the same value as one that grows steadily, but the ride is very different. Two investments with the same CAGR can carry very different risk, so CAGR alone does not tell you whether the return was worth the volatility.

Fees, Taxes and Inflation

A return is only meaningful after costs. Subtract trading fees, fund charges and taxes before calculating ROI, because a 40% gross gain might be 34% after costs. Then adjust for inflation to find the real return: real return = (1 + nominal return) ÷ (1 + inflation) − 1. With a CAGR of 8.78% and inflation of 3%, the real return is 1.0878 ÷ 1.03 − 1 = 5.61%. Read more about this in our guide to inflation and your savings.

When You Add Money Over Time

CAGR works only for a single starting amount and a single ending amount. If you invest regularly, the right tool is the internal rate of return (IRR), which accounts for the timing of every deposit and withdrawal. Many investment platforms report it as a money-weighted return. For investments that follow a regular schedule, see how dollar-cost averaging affects results.

ROI in Business and Marketing

ROI is also used for business decisions: (revenue generated − cost) ÷ cost. If an advertising campaign costs 2,000 and generates 5,000 in profit before the ad cost, the ROI is (5,000 − 2,000) ÷ 2,000 = 150%. Be consistent about what counts as a cost and which revenue is truly caused by the campaign.

Comparing two investments

Convert both to annual terms (CAGR), subtract fees and taxes, then adjust for inflation. Only then compare them, and look at the worst year as well as the average.