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What is CAGR?
Compound Annual Growth Rate (CAGR) is the average annual rate of return that an investment would need to grow from its beginning value to its ending value over a specified period, assuming profits are reinvested. CAGR smooths out the volatility of year-to-year returns into a single, easy-to-understand number.
How CAGR is Calculated
CAGR = (Final Value / Initial Value)^(1/years) - 1. For example, an investment that grows from $10,000 to $25,000 over 10 years has a CAGR of (25000/10000)^(1/10) - 1 = 9.6%. This means the investment grew at an average rate of 9.6% per year, compounded annually.
CAGR vs Average Return
Simple average return adds up yearly returns and divides by the number of years. CAGR accounts for compounding, making it more accurate for measuring investment performance. For example, if an investment returns +50% year 1 and -50% year 2, the simple average is 0% but the actual result is a 25% loss (CAGR: -13.4%).
Using CAGR for Investment Decisions
CAGR allows fair comparison of investments across different time periods and asset classes. The S&P 500 has a CAGR of approximately 10% over the past 50 years. Real estate has averaged about 4-5% CAGR. Bonds average about 3-5%. Use CAGR to evaluate past performance, but remember that past performance does not guarantee future results.
Frequently Asked Questions
A good CAGR depends on the investment type and risk level. For stocks, 7-10% (after inflation) is historically strong. For bonds, 2-4% is typical. For real estate, 3-5% plus rental income. Any CAGR consistently above 15% over long periods is exceptional and often involves significant risk.
No, CAGR is a nominal return unless you adjust your values for inflation first. To calculate real (inflation-adjusted) CAGR, either use inflation-adjusted values for initial and final amounts, or subtract the average inflation rate (about 2-3%) from the nominal CAGR.
Total return is the overall percentage gain or loss: (final - initial) / initial × 100. CAGR annualizes this return. An investment that doubles ($10K to $20K) has a 100% total return. If it took 7 years, the CAGR is 10.4%. If it took 10 years, the CAGR is 7.2%.
Yes, CAGR is negative when the final value is less than the initial value, meaning the investment lost money overall. For example, an investment that declined from $10,000 to $7,000 over 5 years has a CAGR of -6.9%. Negative CAGR indicates a losing investment.