What is CAGR?
CAGR stands for Compound Annual Growth Rate. It measures how much an investment grows each year on average. Unlike simple returns, CAGR accounts for compounding. It shows the smoothed annual rate you would need to turn your starting value into your ending value.
Think of CAGR as the steady growth rate that would produce the same result as your actual investment. If your stock went up 20% one year and down 10% the next, CAGR gives you one number that represents the overall growth.
The CAGR Formula
CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) - 1
Example Calculation:
Starting investment: $10,000
Ending value after 5 years: $16,000
CAGR = ($16,000 / $10,000)^(1/5) - 1
CAGR = 1.6^0.2 - 1
CAGR = 0.0986 or 9.86%
Your investment grew at 9.86% per year on average.
Why CAGR Matters
CAGR helps you compare different investments fairly. A stock that doubled in 10 years performed differently than one that doubled in 5 years. CAGR reveals which investment actually grew faster annually.
Financial advisors use CAGR to show long-term performance. It smooths out volatility and gives you the big picture. When evaluating mutual funds or stock picks, CAGR tells you what really happened over time.
CAGR vs Simple Average Return
Simple average return just adds up yearly returns and divides by years. This method ignores compounding and can mislead you. CAGR accounts for the fact that losses hurt more than equivalent gains help.
Comparison Example:
Year 1: +50% return
Year 2: -50% return
Simple average = (50% - 50%) / 2 = 0%
But if you invested $100:
After Year 1: $150
After Year 2: $75
CAGR = ($75/$100)^(1/2) - 1 = -13.4%
CAGR correctly shows you lost money.
Using CAGR for Investment Decisions
Compare Different Assets
Calculate CAGR for stocks, bonds, and real estate to see which asset class performed best. Make sure you compare equal time periods for fair results.
Set Realistic Goals
Historical CAGR helps you set achievable investment targets. The S&P 500 has delivered roughly 10% CAGR over long periods. Expecting 30% CAGR every year sets you up for disappointment.
Evaluate Fund Managers
CAGR reveals whether a mutual fund manager actually beats the market. A manager might show good returns in up years but give it all back in down years. CAGR cuts through the noise.
CAGR Limitations
CAGR assumes steady growth, but real investments fluctuate wildly. Two investments with the same CAGR can have very different risk profiles. One might be a smooth ride while the other resembles a rollercoaster.
CAGR also ignores cash flows during the investment period. If you added money or withdrew funds, CAGR gets trickier to calculate correctly. For portfolios with regular contributions, use other metrics alongside CAGR.
Real-World CAGR Examples
Companies report revenue CAGR to show growth. A startup growing from $1M to $10M in revenue over 5 years achieved 58.5% CAGR. That impressive number helps attract investors.
Stock market indices publish historical CAGR data. Knowing the NASDAQ had a certain CAGR over the past decade helps you gauge whether your portfolio keeps pace with the market.
Calculate CAGR for Your Investments
Get your CAGR in seconds with our calculator. Just enter starting value, ending value, and time period.
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