Compound annual growth rate (CAGR) refers to the average annual growth rate of an investment. The CAGR is measured over a specified amount of time and is used by business owners to determine the total returns for an investment.
Investments can fluctuate in value over time. Looking at the mean CAGR over the specified time period can increase the accuracy of the measurements. Business owners can assess their assets and portfolios to effectively manage their finances and investments.
Compound annual growth rate (CAGR) is calculated using a mathematical formula. Investors and businesses use the calculation to determine if their investments are worthwhile and to identify if their assets are gaining or losing value over time.
To calculate CAGR, you need to do the following:
- Divide the value of the investment at the end of the specified time period by its value at the beginning of that time period.
- Raise the answer from step 1 to the power of one divided by the total number of years in the investment period.
- Subtract one from the answer from step 2.
- Multiply the answer from step 3 by 100 to convert the answer into a percentage.
The mathematical formula for CAGR is as follows:
CAGR, year X to year Z = [(value in year Z/value in year X) ^ (1/N)-1]
The answer to a CAGR calculation displays the rate of return (RoR) that is needed for an investment to gain value from beginning to end.
The formula above is complicated. Luckily, you can use an online CAGR calculator to help you. Simply insert the relevant information into the online calculator and you will get an accurate CAGR figure.
Because market rates are constantly changing, CAGR can never be 100% accurate. CAGR is an estimate. It’s not the true return rate but it can be helpful for investors to calculate to determine whether to invest more in certain assets.
It displays the rate at which an investment would grow if the return rate remained the same over the investment period, assuming the profits were reinvested every year.
It’s highly unlikely that an investment will yield the same return rates every year but CAGR enables business owners and investors to understand their assets more easily.
CAGR can be used to track the performance of a variety of business measures between different companies. It can evaluate the progress and success of multiple companies to identify their strengths and weaknesses.
CAGR can be used to compare multiple investments of various types. If an investor has assets with different interest rates, they can compare the CAGR figures of each to determine their total potential return rates.
What CAGR cannot tell you is the risk of investing in a specific stock. Since the markets are so volatile, there is no predicting whether certain stocks are going to rise or fall over a set period of time.
Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence.