What is the Compound Annual Growth Rate (CAGR)?

The Compound Annual Growth Rate (CAGR) is the rate of return (RoR) that would be required for an investment to grow from its beginning balance to its ending balance, assuming profits were reinvested at the end of each period of the investment’s life.

To calculate the CAGR of an investment:

• Divide the value of an investment at the end of the period by its value at the beginning of that period.
• Raise the result to an exponent of one divided by the number of years.
• Subtract one from the next result.
• Multiply by 100 to convert the result to a percentage.

$CAGR = [(\frac{EV}{BV})^{\frac{1}{n}} - 1] * 100$

where:

• $EV$ represents the final value of the portfolio in the interval considered
• $BV$ represents the initial value of the portfolio in the interval considered
• $n$ is the number of years considered

What can the CAGR tell you?

The compound annual growth rate is not a true rate of return, but rather a representative figure. It is essentially a number describing the rate at which an investment would grow if it grew at the same rate each year and profits were reinvested at the end of each year.

In reality, this kind of performance is unlikely. However, CAGR can be used to smooth out returns so that they are more easily understood than alternative methods.

Key conclusions

• The Compound Annual Growth Rate (CAGR) is one of the most accurate ways to calculate and determine returns for anything that can rise or fall in value over time.
• Investors can compare the CAGR of two alternatives to evaluate the performance of a stock relative to other stocks in a peer group or a market index.
• The CAGR does not reflect investment risk.