What Is Compound Annual Growth Rate (CAGR)?

CAGR, or Compound Annual Growth Rate, is a financial metric that measures the average annual growth rate of an investment over a specified period of time, typically longer than one year. It provides a smoothed-out view of an investment’s performance by accounting for compounding effects. In quantitative finance, CAGR is used to compare performance of different portfolios. CAGR does not account for investment risk.

Here’s how to calculate CAGR:

  • Beginning Value (BV): Determine the value of the investment at the start of the period.

  • Ending Value (EV): Find the value of the investment at the end of the same period.

  • Number of Years (n): Calculate the total number of years in the investment period.

  • Divide the ending value by the beginning value.

  • Raise the result to an exponent of one divided by the number of years.

  • Subtract one from the subsequent result.

  • Multiply by 100 to express the answer as a percentage.

The CAGR represents the hypothetical constant annual growth rate that would lead to the same final value if the investment grew at that rate every year and profits were reinvested annually. It’s important to note that this smooths out variations in returns and provides a more easily understandable comparison across different investments.

For example, let’s say you invested $10,000 in a portfolio with the following returns:

From Jan. 1, 2018, to Jan. 1, 2019: Portfolio grew to $13,000 (30% in year one). From Jan. 1, 2019, to Jan. 1, 2020: Portfolio was $14,000 (7.69% growth). From Jan. 1, 2020, to Jan. 1, 2021: Portfolio ended at $19,000 (35.71% growth).

While the annual growth rates varied significantly, the CAGR over the entire period would be approximately 23.86%1.

See also