Compound annual growth rate, or CAGR, is a metric in finance used to calculate investments. It is one of the most accurate methods of calculating the rise or fall of your personal investment returns over time.
Here is everything you need to know about CAGR in finance, including what it means, how to calculate CAGR, and its importance to understanding your finances.
What is CAGR in Finance
The compounded annual growth rate (CAGR) is one of the more accurate ways to calculate and determine returns for anything that can rise or fall in value over time. It takes into account the effect of compounding, which means that the growth builds upon itself.
CAGR is useful in helping you evaluate investment opportunities or assess the historical performance of your previous investments. It’s an additional way of comparing investments and seeing which ones were most beneficial during a specific period.
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Here’s how to calculate CAGR:
CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) – 1.
Furthermore, here is a step-by-step guide on how to use this formula to calculate CAGR:
- Divide the value of an investment at the end of the period by its value at the beginning.
- Raise the result to an exponent of one divided by the number of years.
- Subtract one from the subsequent result.
- Multiply by 100 to convert the answer into a percentage
Why is CAGR important?
The compound annual growth rate isn’t a true return rate. Instead, it is a representational figure. Essentially, it’s a number that describes the rate at which an investment would have grown if it had grown at the same rate every year, and the profits were reinvested at the end of each year.
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Furthermore, with this information represented in a single number, you can have a better idea of how an investment performed, assess its growth, and compare it to other investments. This is key to long-term investment planning.
