Compound Annual Growth Rate

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Calculate the growth rate of an investment over a period of time. Explanation of CAGR (Compound Annual Growth Rate).



CAGR - Compound Annual Growth Rate

What is CAGR? Description

Compound Annual Growth Rate is the average annual growth rate of an investment over a specified period of time.

Calculation of Compound Annual Growth Rate. Formula

CAGR is calculated by taking the Nth root of the total percentage growth rate where N is the Number of Years in the period being considered.

CAGR = ( ( End Value / Begin Value )(1 / N ) ) - 1

Usage of CAGR. Applications

  • Calculating and communicating the average returns of investment funds.
  • Demonstrating and comparing the performance of investment advisors.
  • Compare the historical returns of stocks with Bonds or with a savings account.

Strengths of CAGR. Benefits

  • It is a useful formula to evaluate how various investments or a portfolio has performed over time.
  • Can be used for comparing and for evaluating the performance of one stock against other stocks in a peer group or against a market index.

Limitations of CAGR. Disadvantages

  • CAGR assumes that an investment grew at a steady rate. In reality there is volatility: investment results can vary significantly over time. This volatility, or investment risk, is important to consider when one makes an investment decision.
  • CAGR is a historical measure. Historical results are not always a reliable indicator of expected returns in the future.
  • CAGR is sensitive to the period which you consider and it can be easily manipulated: an investment fund may tell you that it achieved an impressive CAGR of 35% over the last three years, but the Begin Value may be taken at a the lowest point that the fund ever had.

Assumptions of Compound Annual Growth Rate. Conditions

  • CAGR assumes that an investment grows at a steady pace. This is normally not the reality. Therefore CAGR is an imaginary conception. It describes the growth of an investment as though it had grown at a steady pace.

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Compare with CAGR: Return on Investment  |  Net Present Value  |  Discounted Cash Flow

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