The Compound Annual Growth Rate (CAGR) is a simple way to measure how an investment or business grows over time, expressed as an annual percentage. It smooths out the ups and downs of growth to show the average yearly return, assuming the growth happens steadily.
Why is CAGR Useful?
- Easy to Understand: It gives a single number to compare the growth of different investments or businesses.
- Smooths Volatility: Unlike simple averages, CAGR accounts for compounding, showing how money grows over multiple years.
- Helps Compare: You can compare the performance of stocks, funds, or even business revenue using CAGR.
How is CAGR Calculated?
The formula is:
CAGR = [(Ending Value / Beginning Value)^(1 / Number of Years)] - 1
Then multiply by 100 to get a percentage.
Example:
- You invest $1,000, and after 3 years, it’s worth $1,331.
- CAGR = [(1,331 / 1,000)^(1/3)] – 1 = 0.1 or 10% per year.
Key Points
- CAGR assumes steady growth, which may not reflect real-world ups and downs.
- It’s great for long-term comparisons but doesn’t show short-term risks or fluctuations.
- Use it to evaluate investments like mutual funds, stocks, or business growth over multiple years.
CAGR is a beginner-friendly tool to understand how your money grows over time!
Well explained