What is CAGR (Compound Annual Growth Rate)?
CAGR (Compound Annual Growth Rate) is a metric that represents the annual growth
rate of an investment over a specified period, assuming the investment grows at a steady rate and
profits are reinvested (compounded) each year. It provides a smoothed, annualized rate of return,
making it easier to compare the performance of investments over different time periods.
The formula for CAGR is:
\( \text{CAGR} = \left( \frac{\text{Ending Value}}{\text{Initial Value}}
\right)^{\frac{1}{\text{Number of Years}}} - 1 \)
Where:
- Final Value: The value of the investment at the end of the period.
- Initial Value: The value of the investment at the beginning of the period.
- Number of Years: The duration of the investment period.
Why is CAGR Important?
CAGR is a valuable metric for investors, financial analysts, and businesses because:
-
Simplifies Comparison: CAGR provides a single, standardized figure to compare
the performance of different investments or assets over varying time periods, regardless of
volatility or interim fluctuations.
-
Accounts for Compounding: Unlike simple annual return, CAGR reflects the effect
of compounding, which is critical for understanding long-term investment growth.
-
Smooths Volatility: It ignores short-term fluctuations and provides a
consistent annual growth rate, making it easier to evaluate performance.
-
Widely Used: CAGR is a common metric in finance, used to assess the performance
of stocks, mutual funds, portfolios, or business growth (e.g., revenue or customer base).
-
Helps in Forecasting: CAGR can be used to estimate future investment values
based on historical performance, aiding in financial planning..
Example of CAGR
Scenario
Suppose you invest ₹10,000 in a stock portfolio in 2020, and by 2025, the portfolio
is worth ₹15,000. The investment period is 5 years.
Step-by-Step Calculation
- Inputs
- Initial Value = ₹10,000
- Final Value = ₹15,000
- Number of Years = 5
- Apply the CAGR Formula
\( \text{CAGR} = \left( \frac{\text{₹15,000}}{\text{₹10,000}} \right)^{\frac{1}{\text{5}}} - 1
\)
\( \text{CAGR} = ({\text{1.5}})^{\frac{1}{\text{5}}} - 1 \)
\( \text{CAGR} = {\text{1.08447}} - 1 \)
\( \text{CAGR} = \text{0.08447 or 8.447%}\)
- Result: The CAGR is approximately 8.45% per year.
This means the investment grew at an equivalent steady annual rate of 8.45%
over the 5 years, accounting for compounding.
Interpretation
- The portfolio’s value increased by 50% (₹5,000 gain) over 5 years, but CAGR translates this into
a consistent annual growth rate of 8.45%.
- You can compare this CAGR to other investments (e.g., a mutual fund with a 7% CAGR) to determine
which performed better on an annualized basis.
Real-World Application:
If you’re comparing two mutual funds:
- Fund A grew from $10,000 to ₹14,000 in 4 years (CAGR ≈ 8.78%).
- Fund B grew from $10,000 to ₹15,000 in 5 years (CAGR ≈ 8.45%). Even though Fund B has a higher
absolute return, Fund A has a higher CAGR, indicating better annualized performance.
How to Use Online CAGR Calculator ?
Want to know how fast your investment is growing each year? Our CAGR Calculator makes it easy to find
your Compound Annual Growth Rate. Follow these quick steps to get started!
Step-by-Step Guide
- Initial Investment: Type the amount you invested at the start (e.g., ₹10,000)
in the "Initial Investment" field.
- Final Amount:Input the current value of your investment (e.g., ₹15,000) in the
"Final Value" field.
- Number of Years:Enter how long you held the investment (e.g., 5 years) in the
"Number of Years" field.
- Hit the "Calculate CAGR" button, and voilà! You’ll see your CAGR as a percentage (e.g., 8.45%).
- Understand Your Result:A higher CAGR means faster growth. Compare it with other
investments to see which performs better!
Thanks for using our CAGR Calculator tool.Happy Investing
😊
