Measuring Investment Success: ROI & CAGR
Return on Investment (ROI) evaluates the financial efficiency of an asset or business venture. For multi-year holdings, Annualized ROI (CAGR) provides the true geometric rate of return.
Simple ROI vs. Annualized Return (CAGR)
Simple ROI calculates the total percentage gain over an entire holding period, but ignores duration. A 50% return achieved over 2 years represents a 22.5% annualized return, whereas the same 50% return over 10 years represents only a 4.1% annualized return.
Compound Annual Growth Rate (CAGR)
CAGR = (Ending Value / Beginning Value)^(1 / Years) - 1
CAGR standardizes volatile returns into a constant annual growth rate, allowing fair, direct performance comparisons between different asset classes and holding periods.
ROI Evaluation Checklist
- Factor in Total CostsAlways deduct transaction commissions, taxes, maintenance, and carrying costs from your gross profit before computing net ROI.
- Adjust for InflationDeduct the prevailing inflation rate from your nominal CAGR to measure your real purchasing power gains.
- Assess Risk AdjustmentsA high ROI on a high-volatility asset must be weighed against the probability of permanent capital loss.