Glossary Term
CAGR
Compound Annual Growth Rate is the mean annual growth rate of an investment over a specified period.
Detailed Explanation
The Compound Annual Growth Rate (CAGR) is one of the most accurate ways to calculate and determine returns for anything that can rise or fall in value over time. Unlike an average return, CAGR takes into account the compounding effect of an investment. It answers the question: 'If my investment grew at exactly the same steady rate every single year, what would that rate be?'
The Formula
CAGR = [ (Ending Value / Beginning Value) ^ (1 / Number of Years) ] - 1Real-World Example
If you invest $10,000 and it grows to $15,000 in Year 1, then drops to $12,000 in Year 2, your simple average return might look positive, but your true CAGR over the 2 years is exactly 9.54%.
Key Takeaways
- •CAGR smooths out the volatility of year-to-year returns.
- •It is the standard metric used to compare the historical performance of different assets or mutual funds.
- •CAGR assumes that all dividends and interest are reinvested.