CAGR - Compound Annual Growth Rate
What is CAGR?
CAGR Formula and Example
You can calculate CAGR by using the following formula:
CAGR = ( EV / BV)1 / n - 1
EV = Investment's ending value
BV = Investment's beginning value
n = Number of periods (months, years, etc.)
As an example, let's say you invest $1,000 in Fund XYZ for five years. The year-end value of the investment is listed below for each year.
Year Ending Value
1 $ 750
We can calculate the CAGR of the investment as:
CAGR = ( 5,000 / 1,000)1/5 - 1 = .37973 = 37.97%
TIP: If you are using a financial calculator, use the yx button to raise ( 5,000 / 1,000) to the power of 0.20 (since 1 / 5 = 0.20 ).
[Our easy to use CAGR Calculator can help you project the CAGR needed to achieve your investment goals or measure the return on existing investments.]
How to Calculate Growth Rate for an Investment
For example, consider Year 1 and Year 2 of our hypothetical investment in Fund XYZ. At the end of Year 1, the portfolio value had fallen from $1,000 to $750 for a return of -25% [ (750 - 1,000) / 1,000 ]. By the end of Year 2, the portfolio value had grown by +33% [ (1,000 - 750) / 750 ].
Averaging the Year 1 and Year 2 returns over two years gives us an average return of 4% [ (-25 + 33) / 2 ], but that doesn't accurately reflect what has happened. We began with $1,000 and ended with $1,000, which is a return of 0%.
This example shows why CAGR is a better measure of return over time. Average annual return ignores the effects of compounding and it can overestimate the growth of an investment. CAGR, on the other hand, is a geometric average that represents the one, consistent rate at which the investment would have grown if the investment had compounded at the same rate each year.