Understanding CAGR
CAGR stands for Compound Annual Growth Rate. It represents the mean annual growth rate of an investment over a specified period longer than one year, assuming the investment compounds annually.
Unlike simple returns, CAGR smooths out volatility and provides a single percentage that represents consistent annual growth. If your investment grew 50% in year one and declined 10% in year two, CAGR gives you the equivalent steady annual rate.
The CAGR Formula
This formula accounts for compounding and time, giving you the true annualized growth rate.
CAGR vs Other Return Metrics
CAGR
Best for: Long-term performance comparison
Smooths volatility, accounts for compounding, time-adjusted returns.
Simple Return
Best for: Quick snapshots
Shows total gain/loss but ignores time factor and compounding effects.
Average Return
Best for: Year-by-year analysis
Arithmetic mean of annual returns, can be misleading for volatile investments.
CAGR in Action: Real Example
Mutual Fund Investment Analysis
CAGR Calculation:
- Formula: (2,50,000 ÷ 1,00,000)^(1/5) - 1
- Step 1: 2.5^(0.2) = 1.2011
- Step 2: 1.2011 - 1 = 0.2011
- CAGR: 20.11% per year
Interpretation: The investment grew at an equivalent rate of 20.11% annually, which is excellent performance for equity mutual funds.
When CAGR is Most Useful
Comparing Different Investments
CAGR allows fair comparison between investments with different time periods and volatility patterns.
Evaluating Fund Performance
Mutual fund performance is typically measured using CAGR over 3, 5, and 10-year periods.
Setting Realistic Expectations
CAGR helps set realistic long-term return expectations based on historical performance.
Business Growth Analysis
Companies use CAGR to measure revenue, profit, and other business metrics over time.
Common CAGR Mistakes
Using CAGR for SIP Investments
CAGR assumes a single lump sum investment. It fails to account for multiple cash flows at different times.
Ignoring Volatility
CAGR smooths out the journey. Two investments can have the same CAGR but vastly different risk levels.
Cherry-Picking Time Periods
Starting calculation at a market bottom and ending at a top artificially inflates the growth rate.
Calculate Your CAGR
Our advanced CAGR calculator helps analyze investment performance with detailed breakdowns.