What is CAGR?

• CAGR (Compound Annual Growth Rate) shows the average yearly growth of an investment, including compounding.

• It's more accurate than just looking at raw returns or yearly changes.

• CAGR is useful for comparing investments or tracking progress toward goals.

• The CAGR formula is simple:

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

• It doesn’t show volatility or ups and downs, only the smoothed-out growth rate.

CAGR stands for Compound Annual Growth Rate, and it's the number when you want to know how fast something grew over several years on average.

CAGR is basically the rate at which your investment would have grown each year if it had grown at the same pace annually. Think of it as the "smooth" growth rate. Real investments bounce up and down, but CAGR ignores the rollercoaster and shows you the average slope from start to finish. So if you put in $5,000 and after 5 years it's worth $10,000, CAGR tells you the exact yearly growth that got you there, as if it were steady all along.

So how do you calculate CAGR? It's actually easy when you learn the formula. You need three things to calculate CAGR:

1. Beginning value of your investment.
2. Ending value of your investment.
3. Number of years the investment lasted.

Then, you apply the CAGR formula (we'll break it down in the next section).

For example, imagine you invest $1,000 in a stock, and after 4 years, it's worth $1,500. Using CAGR, you can determine what constant annual rate would turn $1,000 into $1,500 over 4 years. This makes comparing that investment to others, like bonds or funds, much easier because you're looking at a single number rather than messy year-to-year changes.

Now that we know what CAGR means, let's take a look at the CAGR formula:

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

where:

• Beginning Value — what you started with;
• Ending Value — what it grew to; and
• Years — the number of years you held it.

For example, if you invested $10,000 and it multiplied to $16,000 in 5 years, your CAGR is:

CAGR = (16,000 / 10,000)^(1/5) - 1 = 0.0968 = 9.68% per year.

That means your investment grew at an average rate of 9.68% per year, even if some years were higher and some lower.

The annual growth rate (AGR) shows the change from one year to the next, while CAGR smooths everything out. If your investment went +20%, then -10%, then +15%, annual growth rates make it look chaotic. CAGR would give you a single "average" growth rate over the whole period.

In summary:

• AGR — short-term view, can swing a lot.
• CAGR — long-term average, more useful for comparisons.

That's why analysts and investors prefer CAGR when they’re talking about performance over multiple years.

Both CAGR and IRR (internal rate of return) show growth, but are not the same. CAGR is simpler because it assumes you invest once at the start and measure the growth to the end (or at least it shows that). IRR is a bit more complex as it takes into account multiple cash flows in and out during the investment period. So if you're comparing savings or a stock investment growth, CAGR works fine, but IRR is usually the better tool for analyzing a business project or real estate deal.

To sum up:

• CAGR — Easy to calculate, good for buy and hold investments.
• IRR — More detailed, good for projects with many inflows and outflows.

While CAGR is very useful, it's not perfect. It doesn't show the bumps along the way, but only the smoothed-out average, which can hide changes throughout the investment period. For example, an investment could drop 50% one year and double the next. The CAGR might look healthy, but it doesn't show the risk or stress of those big swings.

Let's look at a real-life example to understand the theory. For example, if you invest $5,000 in a mutual fund, and after 10 years, it's worth $12,000. So our CAGR is:

CAGR = (12,000 / 5,000)^(1/10) - 1 = 9.1% per year

That means, on average, your investment grew about 9% per year. But maybe one year it lost 20% and another year it gained 25%. CAGR doesn't show those details - it just gives you the big picture. Outside investing, companies also use CAGR to show things like sales growth, customer growth, or even website traffic. For example, "Our revenue grew from $1M to $3M in 4 years, a CAGR of 31.6%" is a simple way to tell a growth story without drowning people in numbers.

CAGR is an investment's average annual growth rate, taking compounding into account. It's easy to calculate, great for comparing investments, and widely used in finance, but remember its limits — it smooths out volatility and doesn't show risk. To really understand performance, pair CAGR with other tools like IRR calculator 🇺🇸 or investment calculator 🇺🇸.