Compound Annual Growth Rate (CAGR)
What Is Compound Annual Growth Rate (CAGR)?
Compound Annual Growth Rate (CAGR) is the average annual growth rate of an investment over a specific period, assuming profits are reinvested each year.
CAGR represents the smoothed annual return of an investment.
Why It Matters
Investors use CAGR to compare the performance of different investments over time. It provides a clearer picture of long-term growth than simple average returns.
CAGR accounts for the effects of compounding, which occurs when investment earnings generate additional earnings.
How CAGR Works
CAGR calculates the annual rate at which an investment grows from its starting value to its ending value over a period of time.
Key inputs include:
- beginning value
- ending value
- number of years invested
The result represents the constant annual rate needed to achieve the final investment value.
Example
An investment grows from $10,000 to $18,000 over six years.
The CAGR represents the steady annual rate that would produce this growth.
CAGR vs Average Return
- CAGR accounts for compounding and provides a smoothed growth rate.
- Average return simply averages yearly returns without accounting for compounding effects.
FAQs About CAGR
Why is CAGR useful?
It allows investors to compare investments with different time horizons.
Does CAGR show yearly volatility?
No. It represents an average growth rate over time.
Can CAGR be negative?
Yes. If an investment declines in value over time.
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