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We use money to pay for things all the time, yet many of us don’t stop to think about what gives it value. A paper bill or digital balance on your checking account has no real worth on its own. So why does it work? The answer lies in the fiat money system.

Fiat money is currency that has value not because it’s backed by a physical commodity like gold or silver, but because governments declare it legal tender and people trust that it will be accepted. In the U.S., fiat money is simply the dollars and cents we use every day. In the UK, it’s pounds, and in Japan, it’s yen. Below, we’ll explore how fiat currency works, how it came to be, its pros and cons, and what the future may hold as digital currencies rise in influence.

What Is Fiat Money?

Fiat money, or fiat currency, is a form of exchange or legal tender that’s backed by faith in the government, not an underlying asset like silver or gold. You can also think of fiat money as a national or regional currency. Examples of fiat currency include the dollar In the U.S., the pound in England, and the yen in Japan. Fiat money gets its value from public trust in the issuing government, the stability of that government, and the dynamics of supply and demand.

Fiat money is different from commodity money (like gold), which is tied to a tangible good’s inherent value, and digital currencies (such as cryptocurrency), which have no tangible form.

Origin and Meaning of the Term “Fiat”

“Fiat” is a Latin word that means “let it be done,” referring to an authoritative declaration or command. This term was chosen for fiat money because the money’s value is established by a government’s authority, not by its intrinsic worth or a commodity like gold. The value of fiat currency relies on public trust in the issuing government and the stability of the economy, making the government’s authority key to its worth.

Fiat Money vs. Commodity Money: Key Differences

Commodity money is a type of currency that is itself a valuable physical good, meaning it has intrinsic value apart from its use as money. A gold coin is valuable both as money and as gold. Commodity money can be used outside the monetary system. For example, silver jewelry retains value regardless of government policy.

By contrast, fiat money has no intrinsic value. A $20 bill is just a piece of money. Its worth comes from collective trust and the fact that the U.S. government requires its acceptance for payments.

A middle-ground money category is representative money, which once dominated economies. Under the gold standard, for example, paper notes were redeemable for a fixed amount of gold stored by the government. Today, however, almost all natural currencies are purely fiat-based.

Why Fiat Money Has Value

While fiat money is not backed by a tangible asset, people accept it in exchange for goods and services. This is due to a combination of legal authority, public trust, and market forces.

The Role of Government Backing and Legal Tender Laws

Fiat money is backed by the authority of the government that issues it. For example, the U.S. dollar is backed by the “full faith and credit of the U.S. government.”

Legal tender laws specify which types of fiat money are considered valid currency. American law, for example, states that:

“United States coins and currency (including Federal Reserve notes and circulating notes of Federal Reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues. Foreign gold or silver coins are not legal tender for debts.”^[1]

This definition specifically refers to physical currency. Debit cards, credit cards, and personal checks are not included, since they’re payment methods. However, they’re all tied to fiat money.

By this definition, digital currencies are also excluded. While you could technically use a digital currency to pay for goods or services, the currency itself has no backing from the U.S. government and is not legal tender.^[2]

Public Trust and Perception

Ultimately, fiat money relies on trust. People accept dollars, euros, or yen because they believe others will also accept them tomorrow. This collective belief gives the currency stability.

Trust can be strengthened by sound monetary policy, low inflation, and political stability. Conversely, when trust erodes, people may abandon the currency in favor of alternatives such as foreign money, commodities, or even barter.

Determinants of Fiat Currency Value

The value of fiat money is tied to several factors, some of which we’ve already mentioned. The most significant influences include:

•   Public perception and confidence

•   Government stability

•   Economic policies and conditions

•   Supply and demand

It’s the role of central banks to promote economic and monetary policies that are designed to lend stability to the money supply and currency valuations. In the U.S., the Federal Reserve (aka, “the Fed”) is tasked with conducting monetary policy. The Fed manages the value of fiat money primarily by controlling the money supply through three main tools: open market operations, interest rate adjustments, and reserve requirements.

By buying or selling government securities, setting benchmark interest rates, and influencing how much money banks must hold in reserve, the Fed can stimulate or slow economic activity, manage inflation, and maintain public trust in the currency’s stability and purchasing power.

Fiat Money: Past and Present

Understanding the origins of fiat currency can offer a perspective on why it’s become so important today.

Early Examples and Global Development

Asset-backed coins and paper money are believed to have first emerged centuries ago in China. This representative money caught on because people could use it to pay for goods and services — and also redeem it for its underlying commodity. Eventually, the use of physical money spread to Japan and other parts of Asia.

Silver and gold coins were the standard for payment in Europe until the first paper banknote was printed in Sweden in 1661. However, these notes were backed by a government guarantee to redeem them for gold and silver. That likened them to promissory notes, rather than a form of fiat money.

The United Kingdom, and later the U.S., used the gold standard to determine currency values. Under a gold standard system, a country’s money supply is tied to gold. A certain unit of currency is assigned a value based on a certain amount of gold.

The Move from Gold Standard to Fiat Systems

For much of modern history, nations operated under the gold standard, where currencies were tied to a specific amount of gold. This created stability but also limited governments’ flexibility during economic crises.

The turning point came during the 20th century. After the Great Depression and World War II, the Bretton Woods system established the U.S. dollars as the world’s reserve currency, pegged to gold. However, by the early 1970s, mounting economic pressures led President Richard Nixon to suspend dollar convertibility into gold. This effectively ended the gold standard and ushered the global fiat system we know today.

Here’s a look at other notable milestones in U.S. currency history:^[3]

•   1690: First issuance of paper notes in the Massachusetts Bay colony.

•   1739: Ben Franklin introduces anti-counterfeiting measures to stop the illegal reproduction of paper notes.

•   1775: The Continental Congress issues paper money to fund the Revolutionary War; lack of government backing results in a dramatic loss of value.

•   1791: Alexander Hamilton establishes the Bank of the United States to facilitate borrowing and lending for the U.S. government.

•   1861: “Greenbacks” are issued to finance the Civil War.

•   1862: Legal tender notes are issued in denominations of $1, $2, $5, $10, $20, $50, and $100.

•   1913: Federal Reserve Act establishes the Federal Reserve as the nation’s central bank.

•   1971: Nixon takes the U.S. off the gold standard.

Fiat Money in Modern Economies

Fiat money is the standard currency globally. Governments issue fiat currencies, which can be exchanged for other currencies. For example, if you’re traveling to Asia you could exchange dollars for Japanese yen or South Korean won.

The existence of fiat currencies is what powers governments and gives them the authority to direct monetary policy and the broader economy. Adjusting the money supply or interest rates, for instance, can help promote stability in times of economic uncertainty. The more volatile nature of commodities makes commodity money less attractive as a world currency.

While governments can and do maintain gold reserves, the value of the country’s currency is not dependent on that. That also allows for greater flexibility in managing and regulating currency and the money supply.

Advantages and Disadvantages of Fiat Money

Fiat currencies have many attractions, but they aren’t foolproof. Comparing the pros and cons of fiat money can help in understanding its importance and role on the global stage.

Advantages:

•   Flexibility: Fiat money allows for flexibility in managing economic policy and the money supply, potentially reducing the risk of banking disruptions.

•   Efficiency: Unlike commodity money, fiat money does not rely on scarce resources like gold.

•   Support for modern economies: Fiat money enables complex financial systems, credit expansion, and international commerce.

•   Portability and convenience: Paper bills and digital balances are easier to use than heavy coins and bullion.

Disadvantages:

•   Risk of inflation: Without strict limits, governments can over-issue money, eroding value.

•   Dependence on trust: If public confidence collapses, fiat money can quickly lose worth.

•   Potential for mismanagement: Poor monetary policy or political instability can trigger crises.

•   No intrinsic value: Unlike gold, fiat money has no fallback use if confidence collapses.

Real-World Examples of Fiat Money

If you need an example of fiat currency, look no further than your wallet. However, the dollar is just one type of fiat money in existence.

Major Fiat Currencies in Circulation

Most currencies today are fiat money. Some of the most significant fiat currencies include:

•   U.S. dollar

•   Mexican peso

•   Canadian dollar

•   Indian rupee

•   Japanese yen

•   Chinese yuan

•   South Korean won

•   British pound

•   Euro

•   Australian dollar

•   New Zealand dollar

Notable Cases of Fiat Currency Failure

There are several instances of fiat currency failures throughout history. Some of the currencies that have collapsed in the modern era include the:^[4]

•   Zimbabwe dollar (2000s)

•   Belorussian ruble (1990s)

•   Venezuelan bolivar (1990s – present)

•   Russian ruble (1990s)

•   Indian rupee (1990s)

•   German papiermark (1920s)

The collapse of the papiermark after World War I is notable because of the sheer size of the gap between its value and the dollar. In 1923, you would have needed 4.2 trillion German papiermarks to have the equivalent of one U.S. dollar.

Comparing Fiat Money With Alternatives

Fiat money is the primary means by which global commerce operates. However, a new class of digital currencies is on the rise.

Fiat Money vs. Cryptocurrencies

In recent years, digital currencies like Bitcoin have sparked debates about the future of money. Unlike fiat currencies, cryptocurrencies are managed by a decentralized network rather than any government or single authority.

Transactions made with cryptocurrencies are permanently logged on a ledger known as a blockchain. This ledger is viewable to anyone, therefore functioning as a public database. Cryptocurrencies offer a wide range of potential benefits, including faster transaction speeds, lower fees, and greater accessibility. However, they still face challenges, including price volatility, environmental concerns, and lack of regulation. Security risks and limited consumer protection are also ongoing concerns.

Stablecoins, Digital Assets, and Central Bank Digital Currencies (CBDCs)

Stablecoins are digital currencies whose value is tied to another asset. For example, a stablecoin may be pegged to the U.S. dollar. Most token issuers hold assets in reserve so that stablecoin holders can redeem them at any time. Stablecoins may be bought and sold and used as a form of payment for goods and services.

Accessibility and the potential to earn interest on holdings are fueling interest in stablecoins. However, the safety of a stablecoin depends on its backing assets, the transparency and solvency of its issuer, and the security of the wallet used to store it.

One potentially interesting development in the digital currency landscape could be the advent of central bank digital currencies (CBDC) — virtual currencies that are created and backed by a nation’s central bank.

CBDCs sound to some people like an oxymoron because cryptocurrencies, by definition, are decentralized and don’t have an authority backing them. However, more central banks are exploring the possibilities of using them.

The Future of Fiat Money

Fiat money isn’t going away any time soon, but we may see a blend of traditional systems and digital innovation in the coming years.

The Rise of Digital Currencies and Electronic Payments

The use of digital currencies as a payment method is growing. The federal GENIUS (Guiding and Establishing National Innovation for U.S. Stablecoin) Act, which was signed into law in July 2025, opens the door to a regulatory framework that would allow the use of stablecoins as a form of payment. The Act requires stablecoin issuers to hold reserves in U.S. currency and enforces key rules surrounding transparency. It does not, however, convey government-backed status to stablecoins and prohibits issuers from marketing their coins as being backed or insured by the government.

Changing Role of Central Banks

As the number of digital currencies continues to grow, central banks are increasingly forced to pay attention. The uptick in the number of countries exploring CBDCs is evidence that governments are aware of the risks of digital currencies and are seeking ways to mitigate those risks by integrating them into payment systems.

In the U.S., the Federal Reserve recently withdrew guidance for banks related to crypto assets. They also issued a joint statement with the Office of the Comptroller of the Currency (OCC) and the FDIC addressing the safekeeping of crypto-assets by banks on behalf of their customers, creating a clear signal that banks can serve as custodians of digital assets.^[5]

The Fed has also drafted several papers on the pros and cons of introducing a CBDC in the U.S. In the Board’s opinion, a central bank digital currency would represent a significant innovation and offer Americans access to a form of currency with no liquidity or credit risk.^[6]

It’s unclear whether a CBDC will materialize in the U.S., and questions surrounding the risks of CBDCs continue to be obstacles to widespread adoption.

Ongoing Debates on Stability and Longevity

Cryptocurrency’s decentralized nature puts it at risk for wide swings in valuation. Compared to the dollar or other forms of fiat money, digital currencies may see values go up or down dramatically in a short period of time. Lack of government backing means that public confidence can play an even greater role in determining which way a cryptocurrency’s price moves.

Stablecoins are structured to maintain a relatively stable value and reduce volatility by pegging themselves to fiat currencies. However, concerns remain about how to make digital currencies accessible on a broad scale, as well as their overall longevity. Numerous cryptocurrencies have been abandoned for various reasons, but the common thread among them is that they lost all or nearly all of their value. Stablecoins could depeg, moving farther away from their intended value, for a number of reasons, such as illiquidity, regulatory challenges, or tech failures.

Banks are opening pathways with crypto checking and savings accounts that blend traditional banking with digital asset management. They allow you to hold fiat money in an FDIC-insured bank account while storing cryptocurrency in a secure digital wallet. (Keep in mind, however, that crypto assets are not FDIC insured and may lose value.) These hybrid account options may entice more people to explore digital currencies and help push them to the forefront of financial systems in the U.S. and abroad.

The Takeaway

Fiat money is a form of currency, such as the U.S. dollar or the euro, that is not backed by a physical commodity like gold or silver, but is instead given value by a government’s decree. Its value is based on the trust and confidence that people have in the issuing government and its economy. Most modern economies use fiat money, allowing central banks to control economic factors like inflation by managing the money supply.

Digital currencies offer an alternative to the fiat currency system, and are attracting significant interest from governments and the public due to their potential for faster, cheaper transactions, and new financial applications. These newer currency options range from decentralized cryptocurrencies to stablecoins and CBDCs.

Staying up to date on the latest trends affecting fiat currency and digital currencies can help you make informed decisions with your money.

Soon, SoFi members will be able to buy, sell, and hold cryptocurrencies, such as Bitcoin, Ethereum, and more, and manage them all seamlessly alongside their other finances. This, however, is just the first of an expanding list of crypto services SoFi aims to provide, giving members more control and more ways to manage their money.

Join the waitlist now, and be the first to know when crypto is available.

FAQ

Why does fiat money have value if it isn’t backed by a commodity?

Fiat money has value because people trust the government that issues it and accept it as a medium of exchange. Its worth comes from legal tender laws requiring its acceptance for debts and taxes, along with widespread confidence in its stability. Unlike gold or silver, fiat currency doesn’t rely on intrinsic value but on collective belief in its purchasing power. This is supported by strong institutions, economic productivity, and central bank policies that maintain confidence in the system.

How does fiat money impact inflation and hyperinflation?

Fiat money gives central banks flexibility to manage the money supply, which can help control inflation when used responsibly. However, if too much money is printed without corresponding economic growth, inflation rises as purchasing power declines. In extreme cases, such as political instability or uncontrolled spending, this can spiral into hyperinflation, where prices skyrocket, and money rapidly loses value. Fiat money’s reliance on government discipline makes inflation risk management crucial to maintaining trust and economic stability.

How is fiat money regulated?

Fiat money is regulated primarily by central banks, which oversee its issuance and circulation. They use tools like interest rates, reserve requirements, and open market operations to control money supply and maintain price stability. Governments also enforce legal tender laws, banking regulations, and anti-counterfeiting measures. Financial institutions also play roles in monitoring cross-border flows and exchange rates. This system of regulation ensures fiat money remains stable, trustworthy, and effective as a medium of exchange in modern economies.

Are cryptocurrencies likely to replace fiat money?

Cryptocurrencies provide decentralized, borderless transactions, but they face challenges in replacing fiat money. Most lack price stability, broad adoption, and government backing, making them less practical for everyday use. Governments also prefer to retain monetary control, which cryptocurrencies bypass.

While digital assets may complement fiat money, offering alternatives for financial portfolios or niche transactions, full replacement is unlikely soon. Instead, central banks are exploring central bank digital currencies (CBDCs), which blend digital innovation with government oversight, bridging the gap between crypto and fiat.

What happens if trust in a fiat currency disappears?

If people lose trust in a fiat currency, its value can collapse because it depends on public confidence rather than intrinsic worth. In such cases, individuals may turn to foreign currencies, commodities like gold, or even barter to preserve purchasing power. Severe loss of trust often leads to hyperinflation, economic instability, and social unrest. Governments may respond with monetary reforms, introducing a new currency, pegging value to a commodity, or adopting international support to restore stability and rebuild confidence.

Why do governments continue to use fiat money over alternatives?

Governments use fiat money because it’s stable, reliable, and flexible. Fiat currencies can be exchanged for goods and services in countries around the world. There’s no need to store large quantities of physical commodities, like gold or silver, that in the past have been used to determine the value of currency.

Governments use fiat money because it provides flexibility to manage economies. Unlike commodity-backed systems, fiat currency allows central banks to adjust supply in response to crises, growth, or inflation. It also simplifies transactions, reduces reliance on scarce resources, and supports modern financial systems like credit and banking. Alternatives, such as gold standards or purely decentralized currencies, limit monetary policy options.

What makes fiat currencies different from digital assets?

Fiat currencies are government-issued, legally recognized as legal tender, and regulated by central banks. They rely on public trust and institutional backing, ensuring broad acceptance for everyday transactions. Digital assets, such as cryptocurrencies, are decentralized, often unregulated, and rely on blockchain technology rather than government authority. While fiat money is relatively stable, most digital assets are volatile and speculative. In addition, fiat currencies integrate seamlessly into traditional financial systems, while digital assets operate outside them, offering new opportunities but also greater risks.

Article Sources

1. Cornell Law School. 31 U.S. Code § 5103 – Legal tender.
2. IRS. Digital assets.
3. U.S. Currency Education Platform. The History of U.S. Currency.
4. Gold IRA Guide. The World’s 20 Greatest Currency Failures.
5. FDIC. Agencies Issue Joint Statement on Risk-Management Considerations for Crypto-Asset Safekeeping.
6. Board of Governs of the Federal Reserve System. Federal Reserve Board announces the withdrawal of guidance for banks related to their crypto-asset….

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About the author

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Cryptocurrency and other digital assets are highly speculative, involve significant risk, and may result in the complete loss of value. Cryptocurrency and other digital assets are not deposits, are not insured by the FDIC or SIPC, are not bank guaranteed, and may lose value.

All cryptocurrency transactions, once submitted to the blockchain, are final and irreversible. SoFi is not responsible for any failure or delay in processing a transaction resulting from factors beyond its reasonable control, including blockchain network congestion, protocol or network operations, or incorrect address information. Availability of specific digital assets, features, and services is subject to change and may be limited by applicable law and regulation.

SoFi Crypto products and services are offered by SoFi Bank, N.A., a national bank regulated by the Office of the Comptroller of the Currency. SoFi Bank does not provide investment, tax, or legal advice. Please refer to the SoFi Crypto account agreement for additional terms and conditions.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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The payback period is when an investment generates enough cashflow or value to cover its initial cost. It’s the time it takes to get to the break-even point. Knowing the payback period is something that investors, corporations, and consumers use as a way to gauge whether an investment or purchase is likely to be profitable or worthwhile.

For example, if a $1 million investment in new technology is likely to increase company revenue by $200,000 a year, the payback period for that technology is five years.

A longer payback period is associated with higher risk, and a shorter payback period is associated with lower risk and a greater potential for returns. While calculating the payback period is fairly straightforward, it doesn’t take into account a number of factors, including the time value of money.

What Is the Payback Period?

The payback period is the amount of time it will take to recoup the initial cost of an investment, or to reach its break-even point.

Although investors who are thinking about buying stock in a certain company may want to consider the payback period for certain capital projects at that company (and whether those might support growth), the payback period is more commonly used for budgeting purposes by companies deciding how best to allocate resources for maximum return.

While the payback period is only an estimate, and it doesn’t factor in unforeseen or future outcomes, it’s a useful tool that can provide a baseline for assessing the relative value of one investment over another.

The Value of Time

The payback period can help investors decide between different investments that may be similar, when investing online or via a broker-dealer, as they’ll often want to choose the one that will pay back in the shortest amount of time.

The longer money remains locked up in an investment without earning a return, the more time an investor must wait until they can access that cash again, and the more risk there is of losing the initial investment capital.

Recommended: How to Calculate Expected Rate of Return

How to Calculate the Payback Period

The payback period is calculated by dividing the cost of the investment by the annual cash flow until the cumulative cash flow is positive, which is the payback year. Payback period is generally expressed in years.

Prior to calculating the payback period of a particular investment, one might consider what their maximum payback period would be in order to move forward with the investment. This will help give them some parameters to work with when making investment decisions.

Payback Period Formula (Averaging Method)

There are two basis payback period formulas:

Payback Period = Initial Investment / Yearly Cash Flow

Using the averaging method, the initial amount of the investment is divided by annualized cash flows an investment is projected to generate. This works well if cash flows are predictable or expected to be consistent over time, but otherwise this method may not be very accurate.

Payback Formula (Subtraction Method)

Using the subtraction method, an investor can start by subtracting individual annual cash flows from the initial investment amount, and then do the division. This method is more effective if cash flows vary from year to year.

Payback Period = the last year with negative cash flow + (Amount of cash flow at the end of that year / Cash flow during the year after that year)

Other factors

Investors might also choose to add depreciation and taxes into the equation, to account for any lost value of an investment over time.

Consumers may want to consider the payback period when making repairs to their home, or investing in a new amenity. For example: How long would it take to recoup the cost of installing a fuel-efficient furnace?

Benefits of Using the Payback Period

The payback period is simple to understand and calculate. It can provide individuals and companies with valuable insights into potential investments, and help them decide which option provides the best return on investment (ROI). It also helps with assessing the risk of different investments. Advantages include:

•  Easy to understand

•  Simple to calculate

•  Tool for risk assessment

•  Helps with comparing and choosing investment options

•  Provides insights for financial planning

•  Other calculations, such as net present value and internal rate of return, may not provide similar insights

•  A look at the amount of time it takes to recoup an investment

Recommended: Stock Market Basics

Downsides of Using the Payback Period

Although the payback period can be a useful calculation for individuals and companies considering and comparing investments, it has some downsides.

A Limited Time Period

The calculation only looks at the time period up until the initial investment will be recouped. It doesn’t consider the earnings the investment will bring in after that, which may either be higher or lower, and could determine whether it makes sense as a long-term investment.

If earnings will continue to increase, a longer payback period might be acceptable. If earnings might decrease after a certain number of years, the investment may not be a good idea even if it breaks even quickly. On the other hand, an investment with a short lifespan could need replacement shortly after its payback period, making it a potentially poor investment.

Other Factors May Add or Subtract Value

The payback period also doesn’t take into consideration other ways an investment might bring value, such as partnerships or brand awareness. This can result in investors overlooking the long-term benefits of the investment since they’re too focused on short-term ROI.

The payback period equation also doesn’t take into account the effects an investment might have on the rest of the company’s operations. For instance, new equipment might require a significant amount of expensive power, or might not be able to run as often as it would need to in order to reach the payback goal.

The Time Value of an Investment

Another limitation of the payback period is that it doesn’t take the time value of money (TVM) into account. The time value of money is the idea that cash will be worth more in the future than it is worth today, due to the amount of interest that it can generate.

Not only does this apply to the initial capital put into an investment, but it’s also important because as an investment generates returns, that cash can then be reinvested into something else that earns interest or income. This is another reason that a shorter payback period could be viewed as an attractive investment.

When Would an Investor Use the Payback Period?

The payback period can apply to personal investments such as solar panels or property maintenance, or investments in equipment or other assets that a company might consider acquiring.

Often an investment that requires a large amount of capital upfront generates steady or increasing returns over time, although there is also some risk that the returns won’t turn out as hoped or predicted.

How Companies Use the Payback Period

Calculating payback periods is especially important for startup companies with limited capital that want to be sure they can recoup their money without going out of business. Companies also use the payback period to select between different investment opportunities or to help them understand the risk-reward ratio of a given investment.

Knowing the payback period is helpful if there’s a risk of a project ending in the future. For example, if a company might lose a lease or a contract, the sooner they can recoup any investments they’re making into their business the less risk they have of losing that capital.

Any particular project or investment can have a short or long payback period. A short period means the investment breaks even or gets paid back in a relatively short amount of time by the cash flow generated by the investment, whereas a long period means the investment takes longer to recoup. How investors understand that period will depend on their time horizon.

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The Takeaway

Understanding the potential payback period for a given investment can help you gauge possible risks and reward for a certain asset, because it helps you to calculate when you’re likely to recoup your initial investment. You can also use the payback period when making large purchase decisions and considering their opportunity cost.

Understanding the way that companies calculate their payback period is also helpful to determine their financial viability and whether it makes sense for you to invest in them as part of your portfolio.

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FAQ

What are the two payback period formulas?

Two of the simplest and most common payback period formulas are the averaging method and the subtraction method.

What does the payback period refer to in investing?

The payback period is the estimated amount of time it will take to recoup an investment or to break even. Generally, the longer the payback period, the higher the risk of the associated investment.

What are some downsides of using the payback period?

The payback period may not consider the earnings an investment brings in following an initial investment, or other ways that an investment could generate value. It also doesn’t take into account the time value of money.

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SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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