Compound Annual Growth Rate
What is CAGR?
The compound annual growth rate or in short, CAGR, is one of the most precise methods to calculate and define returns for an investment over some period.
What CAGR can tell an investor
The compound annual growth rate doesn’t represent the exact return rate, it should be rather viewed as a representational figure. So, the CAGR is a number that shows the rate at which an investment would have increased its value if it had grown at the same rate every year. That’s assuming the earnings were reinvested at the end of each year. Some may argue that it’s unreal for an investment to grow at the same rate every year, and they will be right! The CAGR is usually used to smooth fluctuations of returns for a better understanding.
Formula of CAGR
CAGR = ((value at the end / value at the beginning /) 1 / number of years – 1) x 100
Let’s say a random person has invested $10,000 in a stock portfolio with the following returns:
- From 2018 to 2019, the portfolio grew to $13,000 (the 30% annual growth).
- From 2019 to 2020, the portfolio grew to $14,000 (the 7.69% growth).
- Finally, the portfolio rose to $19,000 in 2021 (or 35.71% from 2020 to 2021).
Let’s calculate the CAGR using the formula above.
CAGR = (($19,000 / $10,000 /) 1 / 3 – 1) x 100 = 23.86%
The compound annual growth rate of 23.86% over three-year investment period allow an investor to evaluate past performance, compare options for the capital, and also make predictions for future investment value.
2022-04-13 • Updated