The CAGR (Compound Annual Growth Rate) formula calculates the single, smoothed annual growth rate an investment would need to grow from its starting value to its ending value over a given number of years, assuming steady compounding. It's the standard way to compare investments that grew unevenly year to year, since it strips out the noise and gives one comparable number.
Formula
CAGR = (Ending Value ÷ Beginning Value)^(1/n) − 1
| Variable | Meaning |
|---|---|
| CAGR | Compound annual growth rate, expressed as a percentage |
| Ending Value | The investment's value at the end of the period |
| Beginning Value | The investment's value at the start of the period |
| n | Number of years between the two values |
Worked Example
An investment worth $10,000 grows to $25,000 over 5 years:
- CAGR = (25,000 ÷ 10,000)^(1/5) − 1 = (2.5)^0.2 − 1 = 20.11%
- Total gain: $25,000 − $10,000 = $15,000
- Absolute return: $15,000 ÷ $10,000 × 100 = 150.00%
Notice that the absolute return (150%) looks far bigger than the CAGR (20.11%), that's expected, since absolute return is the total gain over the whole period, while CAGR expresses the same growth as a single, comparable per-year rate.
Key Things to Know
- CAGR assumes smooth, constant compounding, which real investments rarely follow exactly. It's a useful summary number for comparison, not a description of the actual path the investment took.
- A longer period tends to produce a lower CAGR for the same total growth, since the same overall gain is being spread across more compounding years, always check the time period before comparing two CAGR figures.
- CAGR is best used to compare investments with different time horizons or volatility, since a raw total-return percentage can't be compared fairly across different holding periods on its own.
- XIRR is the better tool when cash flows happen at different points in time, such as multiple SIP instalments, CAGR only works cleanly for a single lump sum invested once and withdrawn once.