Compound Annual Growth Rate Formula

Understanding CAGR: A Key Metric for Investment Performance

Importance of CAGR

Compound annual growth rate (CAGR) is a crucial metric used to evaluate the annualized growth of an investment over a specific period. It measures the average annual increase in the value of an asset, considering the effects of compounding.

Formula and Application

The CAGR formula is:
Ending Value ^ (1 / Number of Years) - 1
where the ending value is the final value of the investment, and the number of years is the investment's duration.

This formula helps determine the average annual growth rate that, if earned consistently, would result in the same ending value over the same time period.

Advantages and Limitations

CAGR provides a concise and straightforward measure of investment performance over time. However, it has some limitations:

• It does not account for fluctuations in the investment's value.
• It assumes a constant growth rate, which may not always be accurate.
• It is sensitive to the investment's initial and final values.

Conclusion

CAGR is a valuable tool for evaluating the long-term performance of an investment. By providing an annualized growth rate, it helps investors make informed decisions about their investment strategies. It is important to consider the limitations of CAGR and use it in conjunction with other financial analysis techniques for a comprehensive assessment.