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Compound Annual Growth Rate (CAGR) Calculator

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Understanding Compound Annual Growth Rate (CAGR)

The Compound Annual Growth Rate (CAGR) is a crucial metric used to understand the average annual rate of return of an investment over a specified period of time. It smooths out the volatility of an investment's returns, providing a single, representative growth rate. CAGR is particularly useful for comparing the performance of different investments or for forecasting future growth based on historical trends.

Why is CAGR Important?

CAGR is more representative of growth than simple average returns because it accounts for the effect of compounding. Compounding means that each period's return is calculated on the investment's value, which includes the returns from previous periods. This exponential growth is a fundamental concept in finance.

How is CAGR Calculated?

The formula for CAGR is as follows:

CAGR = [(Ending Value / Beginning Value)^(1 / Number of Years)] – 1

Let's break down the components:

  • Beginning Value: The initial value of the investment at the start of the period.
  • Ending Value: The final value of the investment at the end of the period.
  • Number of Years: The total duration of the investment period in years.

When to Use CAGR

CAGR is widely used in various financial contexts:

  • Investment Performance: Evaluating the historical performance of stocks, mutual funds, real estate, or any asset.
  • Business Growth: Assessing the revenue or profit growth of a company over time.
  • Forecasting: Projecting future values of an investment or business based on historical CAGR.
  • Comparisons: Comparing the growth rates of different investments or companies on an equal footing.

Example Calculation

Imagine you invested $10,000 in a stock at the beginning of 2019. By the end of 2023, your investment has grown to $25,000. The investment period is 5 years.

  • Beginning Value = $10,000
  • Ending Value = $25,000
  • Number of Years = 5

Using the CAGR formula:

CAGR = [($25,000 / $10,000)^(1 / 5)] – 1

CAGR = [(2.5)^(0.2)] – 1

CAGR = [1.2011] – 1

CAGR = 0.2011

To express this as a percentage, we multiply by 100: 0.2011 * 100 = 20.11%.

Therefore, your investment had a Compound Annual Growth Rate of approximately 20.11% over those 5 years. This calculator will help you quickly determine the CAGR for your own investments.

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