CAGR vs. IRR — What's the difference?

• CAGR (Compound Annual Growth Rate) is a simple way to see how much something grows on average per year, including compounding.
• IRR (Internal Rate of Return) measures the annualized return when there are multiple cash flows in and out.
• Use CAGR for simple "buy and hold" growth, and IRR for complex projects with irregular investments.
• Both have strengths and weaknesses, so context decides which one's better.

CAGR stands for Compound Annual Growth Rate. It's the average yearly growth rate of an investment over a set period, assuming the growth happened smoothly each year. In reality, markets move up and down, but CAGR irons out the bumps and shows a clean, comparable figure.

For example, if you invest $5,000 and it grows to $10,000 in 7 years, CAGR tells you the constant yearly percentage that explains that doubling. Investors and analysts love it because it makes comparisons simple: you can look at two different funds or businesses and immediately see which one compounded faster, without worrying about volatility along the way.

IRR stands for internal rate of return, and it's a bit more complicated than CAGR. While CAGR only cares about the starting and ending values, IRR digs deeper. It looks at every cash flow: money going in, money coming out, and when those flows happen.

That makes IRR extremely useful for projects or investments where you don't just invest once and wait. Real estate is a classic example: you put money in at the start, maybe spend more on renovations, collect rental income, and then sell the property years later. IRR ties all of that together into one annualized return number.

The downside is that calculating IRR by hand is painful. Most people use Excel, Google Sheets, or a financial calculator, and speaking of — we have one ready for you to use. Check out the IRR calculator!

If you just want to know how fast your money grew between two points in time, CAGR is the tool for you. It's simple, clean, and perfect for comparing straightforward investments like stocks, bonds, or funds.

But when cash flows get messy — multiple investments, dividend payouts, withdrawals, project expenses — IRR steps in. It tells you whether the overall project was worth it once you account for the timing of all those inflows and outflows.

Basic formula for CAGR can be described as:

CAGR = (Ending Value / Beginning Value)^(1 / Years) - 1

where:

• Beginning Value is what you started with;
• Ending Value is what it became; and
• Years is the time period.

Example: If $10,000 grows to $16,000 in 5 years:

CAGR = (16,000 / 10,000)^(1/5) - 1 ≈ 9.68%

That’s the smoothed-out annual return.

The IRR formula is a bit heavier because it involves cash flows:

0 = NPV = Σ [ Ct / (1 + IRR)^t ]

where:

• Ct — Net cash inflow during period t;
• t — Time period;
• IRR — Rate that makes net present value (NPV) equal to 0.

So IRR is the discount rate that sets the present value of all inflows and outflows equal. Because solving that by hand requires trial and error, spreadsheets are the standard tool. Just type in your cash flows, hit the IRR function, and it spits out the answer.

CAGR is clean and easy, but it has blind spots. It ignores volatility and the bumps along the way. A stock could be down 30% one year and up 50% the next, and CAGR just gives you the average slope.

Other CAGR limitations:

• Assumes growth was steady (which it never really is).
• Doesn't reflect the risk taken to achieve the return.
• Not suitable when there are multiple inflows and outflows.

CAGR is great for comparing "before and after" growth, but it oversimplifies reality.

IRR has its flaws, too. The biggest one is that it can be misleading when cash flows are unusual. Sometimes, multiple IRRs are generated, which makes interpretation tricky.

Other IRR limitations:

• Requires complex calculations or software.
• Can assume reinvestment of cash flows at the same IRR, which isn’t always realistic.

CAGR and IRR both aim to summarize growth, but they answer different questions. CAGR asks, "If growth had been steady, what was the annual rate?" IRR asks, "Given all the cash flows, what was the real annualized return?"

• CAGR is simple, easy, and suitable for clean investments.
• IRR is complex and detailed, and it is best for projects with uneven cash flows.

Neither is "better" overall — they're tools for different jobs. A savvy investor knows when to use each one.