CAGR (Compound Annual Growth Rate)
What is CAGR?
CAGR is the compound annual growth rate of an investment over a certain period of time.
How do you calculate it?
You can calculate CAGR by taking the nth root of the total percentage growth rate, where n equals the number of years.
Formula
CAGR = (Ending Value / Beginning Value) ^ (1 / n) - 1
What is its significance?
CAGR is generally used to think more abstractly about your return on investment. It is not the actual percentage that you make off an investment in a certain period of time. Instead, its a value that describes how fast your investment would have grown if it grows at a steady rate, instead of the varying rates that it actually did grow at. It smoothes out the returns year over year.
Graph of CAGR
The following is the graph of a CAGR curve compared with the actual value of the investment at different points. Notice the smoothing effect of the CAGR curve.
(From Investing Encyclopedia, 2004)
