CAGR Explained: Compound Annual Growth Rate

CAGR, or compound annual growth rate is another financial indicator that can help you through your trading journey which shows the fund’s performance over a specific period. It evens out uneven yearly returns into a simple single figure, this metric usually found on the long-run investment such as mutual funds or other mature company shares.

When a fund reports a 10-year return, or a company reports five-year revenue growth, the figure is usually a CAGR and not the simple average return divided by its period. The two are not the same, and the gap between them is why the metric exists.

This guide covers the formula, a worked example on real data, why CAGR is used instead of an average, and what it hides.

What Is CAGR?

Compound annual growth rate or CAGR is the single annual rate that take a starting value to the ending value if the growth were stable. In reality, there is almost no investment that have a stable growth, this is where the CAGR comes in, it presents a more accurate representation of an investment’s performance by smoothing out the volatility and fluctuations that can occur due to simple annual growth calculations.

Let's take an example of a four-hour drive covering 240 kilometres averages 60 kilometres an hour. The car was stopped at some points and faster at others, and CAGR does the same job for investment growth, each year's growth applies to the total that came before it, not to the original amount. That is why the calculation is not as simple as the average return.

What Is the CAGR Formula?

CAGR = (Ending value / Beginning value)^(1 / Number of years) - 1

To convert it to percentage, you can multiply it by 100.

• Beginning value is what the investment was worth at the start of the period.

• Ending value is what it was worth at the end.

• The number of years is the span between those two dates, not the number of data points you have.

One thing that is worth noticing is prices from the start of 2020 to 2025 are six figures but only have five years of growth. Using six as the number of the years can result in a CAGR that is too low.

Calculating CAGR in a spreadsheet

You can calculate the CAGR in Excel or Google Sheets and it's very simple, the formula is one line.

If the beginning value is in A1, the ending value in A2 and the number of years in A3,

1. Enter the formula: =(A2/A1)^(1/A3)-1

2. Format the cell as a percentage.

Calculating CAGR with a calculator

You can also calculate CAGR directly with the calculator below:

Why Use CAGR Instead of an Average Return?

The CAGR is used simply because it does not overstate what actually happened to the money compared to a simple average which ignores the fact that each year's return applies to a balance that the previous year already changed.

In a $1000 investment, with a simple average that compounds 6.67 percent would give about $1,214, but with the CAGR of 4.59 percent, it will actually hold $1,144. This gap widens as returns get more volatile, a stock that rises 50 percent then falls 50 percent has a simple average of zero. But in value that stock valued at $100 has become $75, a CAGR of minus 13.4 percent.

The choice between the two is not just a reporting convention, a study by Jacquier, Kane, and Marcus, writing in the Financial Analysts Journal in 2003, showed that using a fund's historical arithmetic average to project its future value actually overstates the likely outcome, while using the geometric average, the same calculation behind CAGR, tends to understate it. Their point was that neither number alone is a clean forecast, but the arithmetic average is the more misleading of the two precisely because it ignores how each year's return compounds on the last, the same gap this section's $1,000 example illustrates directly.

Where Do You See CAGR in Practice?

The CAGR appears in various situations, it can be found in fund reporting, company results and index data, even in the US it is written into regulation on SEC Rule 482, the rule requires a fund quoting performance in sales material to disclose its average annual total return over one, five and ten years, using the SEC's formula:

P(1 + T)^n = ERV.

• P is a hypothetical $1,000 payment

• n is the number of years

• ERV is what that payment grew to

• T is the average annual total return.

Rearranging the formula to solve for T equals the same CAGR equation mentioned earlier.. The goal is comparability, since funds reporting the same way can be compared directly, unlike figures based on self-selected periods or non-standard calculations.

Companies also use CAGR, usually to show revenue or earnings growth over three or five years. Index providers use it to express long-run performance.

What Is a Good CAGR?

There is no fixed numbers on the good CAGR, because those numbers requires a a comparable benchmark and a comparable time period.

Take an example of a 7 percent CAGR from a bond portfolio and a 7 percent CAGR from a single technology stock

The CAGR on those investments describe very different things. The range of possible outcomes around them is not remotely similar. The Global Investment Returns Yearbook covers 35 markets from 1900 to 2024. It reports annualised real returns of 5.2 percent for worldwide equities, 1.7 percent for bonds and 0.5 percent for bills.

Small differences in rate produce large differences in outcome over time, which is the practical reason the metric matters.

Compounding is what creates that spread. Those are historical figures for broad asset classes over 125 years, and they describe the past rather than any individual investment's future.

What Are the Limitations of CAGR?

CAGR is a summary, and four things get lost in the summarising.

1. It hides all the volatility

CAGR shows a smooth trajectory that almost never occurs in reality. Two investments can share the exact same CAGR, even though one moves steadily while the other’s value plummets by half at some point along the way this is because CAGR only considers the starting and ending values. This becomes a crucial factor to consider if you might need to liquidate your investment before the term ends.

2. It ignores money added or withdrawn

Since the formula only uses the beginning and ending value from a timespan it will ignore money added or withdrawn. If you added money during the period, CAGR treats that growth as investment performance rather than as deposits. For a portfolio you have been contributing to, CAGR on the account balance is meaningless.

3. The endpoints decide the answer

This indicator can also become subjective because only two dates enter the calculation, so the choice of dates drives the result. Take an investment that doubles over five years, a CAGR of 14.87 percent. Give it a 15 percent fall in the final year instead and the five-year CAGR drops to 8.2 percent, in the same first four years. Periods chosen to start at a low point and end at a high one will always flatter.

4. It is a description, not a forecast

A CAGR records what a rate would have been, and contains no information about what comes next. A fund reporting a 12 percent ten-year CAGR has told you about the past decade and nothing about the next one.

Conclusion

You can now calculate a CAGR, and more usefully, read one that someone else has calculated and know what it does not tell you.

The habit worth building is checking the period before the percentage. A CAGR is only as meaningful as the start and end dates chosen for it. Those dates are usually the first thing a headline figure omits.

Pair the number with the company's earnings report when you want to know why growth happened.

This content is for educational purposes only and is not investment advice or a recommendation to buy or sell any security. Investing carries risk, including the possible loss of principal. Figures cited are from the sources linked, on the dates stated and will change with each reporting period.