Annual Average Compound Growth Rate Calculator
Understanding Annual Average Compound Growth Rate (CAGR)
The Annual Average Compound Growth Rate, commonly known as CAGR, is one of the most accurate ways to calculate and determine the return on an investment or the growth of a business metric over a period of time longer than one year. Unlike a simple average growth rate, which can be misleading due to volatility, CAGR provides a smoothed annual rate of growth as if the investment had grown at a steady rate every year.
This metric is particularly useful for comparing the historical performance of various investments (like stocks, mutual funds, or business revenue) or for projecting future value based on past trends.
The CAGR Formula
The calculation relies on three primary inputs: the starting value, the ending value, and the time period (usually in years). The formula assumes that the profit is reinvested at the end of each year of the time horizon.
Where:
- Ending Value: The value of the asset at the end of the period.
- Beginning Value: The value of the asset at the start of the period.
- n: The number of years involved.
Example Scenario
Imagine you invested $10,000 in a portfolio on January 1, 2018. By January 1, 2023 (5 years later), your portfolio is worth $15,000.
While your total growth is 50%, calculating the annual growth isn't as simple as dividing 50% by 5 years (which would be 10%). Because of the effects of compounding, the actual annual rate required to get from 10k to 15k is lower.
Using the calculator above:
- Beginning Value: 10,000
- Ending Value: 15,000
- Number of Years: 5
The CAGR would be approximately 8.45%. This means if your money grew at exactly 8.45% every year for 5 years, you would reach the same final amount.
Why Use CAGR?
CAGR dampens the effect of volatility of periodic returns that can render arithmetic means irrelevant. It is particularly valuable for investment analysis because it represents the rate of growth that an investment would have required to grow from its beginning balance to its ending balance, assuming the profits were reinvested at the end of each year of the investment's lifespan.