CAGR helps compare returns over time. Discuss your portfolio performance and future investment strategies with our advisors.
What is CAGR (Compound Annual Growth Rate)?
The Compound Annual Growth Rate (CAGR) is a measure of the average annual growth of an investment over a specified period longer than one year. It represents the constant rate at which the investment would have grown if it had compounded at the same rate each year.
CAGR smooths out the volatility of returns that can occur year-to-year and provides a more representative measure of an investment's performance compared to simple average returns.
How CAGR is Calculated
The formula for CAGR is:
CAGR = [(Ending Value / Beginning Value)^(1 / Number of Years)] - 1
The result is usually multiplied by 100 to express it as a percentage.
Why Use CAGR?
Performance Comparison: Allows for easy comparison of the historical performance of different investments (like mutual funds or stocks) over the same period.
Smoothed Returns: Provides a clearer picture of growth by averaging out annual fluctuations.
Goal Setting: Can be used to understand the average annual return needed to reach a future financial goal.
Limitations of CAGR
Assumes Constant Growth: It's a hypothetical measure assuming steady growth, which rarely happens in reality. It doesn't reflect investment risk or volatility.
Doesn't Account for Cash Flows: CAGR calculation only considers the beginning and ending values and the time period. It doesn't account for intermediate additions or withdrawals (for which XIRR is more suitable).
Sensitive to Endpoints: The calculated CAGR can be heavily influenced by the specific start and end dates chosen, especially if those points represent market highs or lows.
Disclaimer: CAGR is a historical performance measure and does not guarantee future returns. Investment decisions should consider various factors including risk tolerance, investment horizon, and diversification, not just past CAGR. Consult a financial advisor for personalized advice.