Metric Guide

Compound Annual Growth Rate

Description

CAGR is an acronym for “Compound Annual Growth Rate”. It refers to the annualized rate of return that an investment has achieved over a certain period of time. It takes into account both the principal investment and any income or gains generated by that investment. CAGR can be used to compare different investments over similar periods of time, such as two stocks in the same industry or two mutual funds with similar objectives.

Calculation

The formula for calculating CAGR is surprisingly simple, given its importance in measuring an investment's performance: CAGR = [(ending value / beginning value) ^ (1/ #of years)] - 1 For example, if you invested $100 at the beginning of 2019 and had $125 at the end of 2020, your CAGR would be calculated as follows: CAGR = [(125 / 100) ^ (1/ 2)] - 1 The result would be 12.5%, which means that your investment had grown at an average rate of 12.5% per year over those two years.

$$\frac{ending\:value}{beginning\:value}^\frac{1}{years} - 1$$
Importance

As noted above, one use for calculating CAGR is comparing different investments over similar periods of time. This can help you make more informed decisions about where to put your money, since you can compare different potential investments side-by-side using their respective CAGRs as a metric for comparison. Additionally, some investors may use their own personal goals in setting a target compound annual growth rate for their portfolio; this target rate will then inform their investing decisions going forward. For example, if an investor has set a goal for their portfolio to grow 8% annually, they may look for investments that are projected to provide returns greater than 8%.

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