What Is Compound Annual Growth Rate (CAGR)?
A 50% gain over 5 years versus a 30% gain over 3 years, which is the better investment? With different periods, a simple comparison is impossible. CAGR solves this problem.
What Is CAGR?
CAGR (Compound Annual Growth Rate) is the annual growth rate assuming compound growth over the investment period. It lets you compare investments of different lengths on the same basis.
Formula: CAGR = (final value / initial value)^(1/years) - 1
Example: if about $7,400 became about $14,800 after 5 years, CAGR = (14,800/7,400)^(1/5) - 1 = 14.87%. It means it grew at 14.87% per year compounded.
CAGR Through Historical Cases
Long-term CAGR of the U.S. S&P 500 (including dividend reinvestment): 1928-2023 (95 years): about 9.8% per year 1993-2023 (30 years): about 10.4% per year 2013-2023 (10 years): about 12.4% per year
CAGR varies by period. "The S&P 500's 10% annual average" is a very-long-term historical estimate, and any particular 10-year span can be much higher or lower. The S&P 500's CAGR for 2000-2010 (including the dot-com bust and financial crisis) was nearly 0%.
CAGR is a measure of past performance. It does not guarantee future returns.
The Limits of CAGR
CAGR looks only at the start and the end. It ignores the path in between.
Even with the same 10% CAGR, one investment may have risen steadily 10% each year, while another fell -50% in the first year and then recovered dramatically over the rest of the period. The two experiences are completely different, yet the CAGR is the same.
This is why it is important to view CAGR alongside MDD (maximum drawdown) and volatility. "High CAGR" does not guarantee a "good investment experience."
Preguntas frecuentes
Q. What is the difference between CAGR and XIRR?
CAGR suits lump-sum investing (putting money in at once and taking it out later). XIRR is used when there are cash flows at multiple points, as in recurring investing. If you invest a fixed amount monthly, XIRR is closer to your real return.
Q. Can I use a short-period CAGR for long-term forecasting?
It is risky. Assuming that because the last 5 years' CAGR was 20% it will continue at 20% can be greatly mistaken. In particular, the CAGR late in a bull market often far exceeds the long-term historical average. For long-term forecasting, refer to the long-term historical CAGR, but it is reasonable to express it as a range.
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