Knowing Compound Annual Growth Rate – CAGR
Compound Annual Growth Rate (or CAGR) is a widely used measure of growth. It is used to evaluate anything that can fluctuate in value, such as assets and investments. CAGR takes the initial investment value and projects an ending investment value while assuming compound growth over a set period of time.
In another way, the result, CAGR, tells you the annual rate of growth your investment would need to have in order to go from its starting amount to its ending amount in the number of years specified
For a market investment, where returns are not guaranteed, the CAGR is best thought of as representative. While your actual results might fluctuate from year to year, if they average out to this rate of return you will reach this ending amount in this number of years.
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 in order to evaluate how well one stock performed against other stocks in a peer group or against a market index.
CAGR does not reflect investment risk.
How to Calculate CAGR
As an example, let's say you invest $1,000 in Fund X for five years. The year-end value of the investment is listed below for each year.
Year Ending Value
You can calculate the CAGR of the investment as:
CAGR = (5,000 / 1,000)1/5 - 1 = .37973 = 37.97%
The RRI function below calculates the CAGR of an investment. The answer is 8%.
Finally, it is always important to remember the critical rule when investing: Past performance is not a promise of future results. The CAGR of investment only tells you how it has done in the past. This might indicate sound management or a good underlying product, but it is not a guarantee. Invest accordingly.