Glossary term
Compound Annual Growth Rate (CAGR)
Compound annual growth rate, or CAGR, is the smoothed annual rate that would take a beginning value to an ending value over a period.
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What Is Compound Annual Growth Rate (CAGR)?
Compound annual growth rate, or CAGR, is the annual growth rate that would turn a beginning value into an ending value over a specific period if growth happened at a steady compounded pace.
CAGR is commonly used to describe investment returns, revenue growth, earnings growth, user growth, and other multi-year changes. It smooths the path into one annualized number.
Key Takeaways
- CAGR shows a smoothed annual growth rate over multiple periods.
- It uses beginning value, ending value, and the number of years.
- CAGR is useful for comparing growth paths with different time lengths.
- It does not show volatility, drawdowns, or the timing of returns.
- CAGR can be misleading if the beginning value is unusually low or the ending value is temporarily high.
CAGR Formula
The common CAGR formula is:
Ending value is the value at the end of the period. Beginning value is the starting value. Years is the length of the measurement period. The result is usually shown as a percentage.
If an investment grows from $10,000 to $16,100 over five years, its CAGR is about 10%. That does not mean it earned exactly 10% each year; it means 10% compounded annually would produce the same ending value.
CAGR Compared With Other Growth Measures
Measure | What it shows | What it misses |
|---|---|---|
CAGR | Smoothed annualized growth | Year-by-year volatility |
Total return | Full gain or loss over the period | Annual pace of growth |
Arithmetic average | Simple average of periodic returns | Compounding effect |
Year-over-year growth | Change from one year to the next | Longer-term trend |
Why It Matters
CAGR makes multi-year comparisons easier. A five-year fund return, a three-year revenue trend, and a ten-year savings projection can be translated into annualized rates that are easier to compare.
It is also useful for goal planning. Investors and businesses can ask what annual growth rate would be required to reach a target value by a future date.
Limits and Misunderstandings
CAGR is not a promise and not a risk measure. Two investments can have the same CAGR while one moves steadily and the other suffers large losses along the way.
CAGR can also hide sequence risk. For retirement withdrawals, cash flows, or leveraged investments, the order of returns may matter as much as the beginning and ending values.
The Bottom Line
CAGR is a clean way to express compounded growth over time. It is useful for comparison, but it should be read with volatility, cash flows, fees, taxes, and the actual path of returns.