Compound Annual Growth Rate (CAGR) Calculator
Understanding the Compound Annual Growth Rate (CAGR)
The Compound Annual Growth Rate (CAGR) is a powerful metric used to measure the average annual growth of an investment over a specified period of time longer than one year. It represents the smoothed-out rate of return, assuming profits were reinvested at the end of each year of the investment's lifespan.
Why is CAGR Important?
- Smooths Out Volatility: Investments rarely grow in a straight line. CAGR helps to ignore the year-to-year fluctuations and provides a single, representative growth rate.
- Comparison Tool: It's an excellent way to compare the performance of different investments over the same time frame, even if their historical performance was erratic.
- Forecasting: While not a predictor of future returns, CAGR can be used in conjunction with other tools to make informed projections about potential future growth.
- Performance Evaluation: It helps investors understand how well their investment strategy has performed on an annualized basis.
The CAGR Formula
The formula for calculating CAGR is as follows:
CAGR = ( (Ending Value / Beginning Value) ^ (1 / Number of Years) ) - 1
Where:
- Ending Value: The value of the investment at the end of the period.
- Beginning Value: The value of the investment at the beginning of the period.
- Number of Years: The total number of years over which the investment grew.
How to Use This Calculator
Simply enter the initial value of your investment, the final value after a certain number of years, and the total number of years. The calculator will then compute the Compound Annual Growth Rate for your investment.
Example Calculation:
Let's say you invested $10,000 in a mutual fund five years ago, and today its value is $25,000. To find the CAGR:
- Beginning Value: $10,000
- Ending Value: $25,000
- Number of Years: 5
Using the formula:
CAGR = ( ($25,000 / $10,000) ^ (1 / 5) ) – 1
CAGR = ( (2.5) ^ (0.2) ) – 1
CAGR = (1.2011) – 1
CAGR = 0.2011 or 20.11%
This means your investment grew at an average rate of 20.11% per year, compounded annually, over the five-year period.