CAGR stands for Compound Annual Growth Rate. It’s a measure that tells you the rate at which an investment would have grown if it grew at a steady rate every year over a specific period. It’s like a financial smoothie blender, turning chunky growth into a silky performance metric.
Here’s the formula (don’t worry, we’ll break it down!):
CAGR = (Ending Value / Beginning Value)^(1/n) – 1
Where n = number of years
👆 By the way, an interesting fact: CAGR is often used in comparing the performance of different investments.
Let’s look at an example:
Imagine you invested $10,000 in a stock, and after 5 years, it’s worth $16,105.
CAGR = ($16,105 / $10,000)^(1/5) – 1 = 1.61^0.2 – 1 = 1.1 – 1 = 0.1 or 10%
This means your investment grew at an average rate of 10% per year over those 5 years.
Now, why does CAGR matter? Here’s why it’s important:

It smooths out volatility: Real growth is often uneven, but CAGR gives you a steady rate.

It allows for easy comparison: You can compare investments with different time frames.

It accounts for compounding: Unlike simple averages, CAGR considers the effects of compounding.

It’s widely used: From stock returns to GDP growth, CAGR is a common metric in finance.
CAGR is used in various contexts:

Investment returns

Revenue growth in business

Market size projections

Population growth
But remember, CAGR isn’t perfect. Here are some limitations:

It assumes steady growth, which rarely happens in reality.

It doesn’t show volatility or risk.

It can be misleading if the start or end point is unusual.
Let’s look at another example to show why CAGR can be more useful than a simple average:
Imagine two investments over 3 years:
Investment A:

Year 1: 20% growth

Year 2: 10% growth

Year 3: 40% growth
Investment B:

Steady 15% growth each year
Both have the same simple average growth (16.67%), but their CAGRs are different:

Investment A CAGR: 14.87%

Investment B CAGR: 15%
CAGR shows that despite the wild ride, Investment A actually performed slightly worse overall!
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