What is CAGR?
The Compound Annual Growth Rate (CAGR) is the rate of return that would be required for an investment to grow from its beginning balance to its ending balance, assuming the profits were reinvested at the end of each year of the investment's lifespan. While actual investments are volatile, CAGR smooths out the returns to make it easier to compare different investments.
For example, if $1,000 grows to $2,000 in 5 years, the total ROI is 100%, but calculating the CAGR is essential to know the annual compounded growth rate.
CAGR Formula:
$$CAGR = \left[ \left( \frac{Final\ Value}{Initial\ Value} \right)^{\frac{1}{n}} - 1 \right] \times 100$$
(Where n is the number of years.)
Frequently Asked Questions (FAQ)
A: Technically yes (e.g., 0.5 years), but CAGR is most reliable for measuring long-term annual performance. ROI is better for short-term trades.
A: It ignores volatility between the start and end dates. It doesn't show the risk an investor faced during the period.
A: The long-term CAGR of major market indices is typically around 7-10%. If your CAGR is higher, you are outperforming the market average.