Investment Analysis

Decoding CAGR: A Guide to Compound Annual Growth Rate

Published on September 9, 2025

When you look at an investment's performance, you'll often see a series of ups and downs. One year it might be up 20%, the next down 10%, and the year after up 15%. So, how do you find a single, steady rate of return that represents the true growth over that entire period? The answer is the Compound Annual Growth Rate (CAGR).

What is CAGR?

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. In simple terms, it smooths out the volatility of returns to give you a single, representative annual growth rate.

The CAGR Formula

The formula to calculate CAGR is:

CAGR = [(Ending Value / Beginning Value)^(1 / n)] - 1

Where:

• Ending Value is the value of the investment at the end of the period.
• Beginning Value is the value of the investment at the start of the period.
• n is the number of years.

For example, if you invest $10,000 and it grows to $15,000 over 3 years, the CAGR would be [($15,000 / $10,000)^(1/3)] - 1 = 14.47%.

Why is CAGR Better Than Simple Average?

A simple average of annual returns can be misleading. Consider an investment that starts at $100. In Year 1, it grows 50% to $150. In Year 2, it falls 50% back to $75. The simple average return is (50% - 50%) / 2 = 0%. This suggests you broke even, but you actually lost $25.

CAGR provides a more accurate picture. The CAGR for this investment would be [($75 / $100)^(1/2)] - 1 = -13.4%. This accurately reflects that you lost money over the two-year period.

Conclusion

CAGR is an essential tool for any serious investor. It cuts through the noise of market volatility to provide a clear and accurate measure of an investment's performance over time. By using CAGR, you can more effectively compare different investments and gain a true understanding of how your portfolio is growing.