What CAGR tells you and what it hides
CAGR, or compound annual growth rate, is the steady return that would have taken an investment from its starting value to its ending value. In practice, it answers a very specific question: if this had grown at the same pace every year, what would that pace have been?
CAGR = (ending value ÷ starting value)^(1 ÷ years) − 1
A step-by-step example
You invest $10,000, and 8 years later you have $25,000.
- Divide the ending value by the starting value: 25,000 ÷ 10,000 = 2.5.
- Raise that to the power of 1 ÷ 8, or 0.125: 2.5^0.125 = 1.1214.
- Subtract 1: 0.1214, or 12.14% a year.
To check it: 10,000 × 1.1214^8 = $25,000. That is the whole definition. It does not say the investment rose 12.14% each year. It says that steady pace would have produced the same result.
Try it with your own figures in the CAGR calculator.
Why the simple average misleads
Say you invest $100. In year one you lose 50%, leaving $50. In year two you gain 100%, returning to $100.
- Simple average of the returns: (−50% + 100%) ÷ 2 = +25% a year.
- What actually happened: you have the same amount you started with, a CAGR of 0%.
That happens because a loss and a gain of the same percentage do not cancel out. After losing 50%, you need a 100% gain to recover. And if you gain 50% and then lose 50%, you end up with $75: a CAGR of −13.4% a year, even though the simple average is 0%.
In a more realistic case, an investment returning +50%, −20%, +30%, −10% and +20% has a simple average of 14% but a CAGR of 11%. Multiply 1.5 × 0.8 × 1.3 × 0.9 × 1.2 and you get 1.68: each dollar became $1.68. The more an investment swings, the wider the gap between those two numbers, and that gap is money you do not have.
When a brochure mentions an “average return,” check whether it is simple or compound. The simple figure is almost always the more flattering one.
What CAGR hides
- The path. Two investments with an 8% CAGR can be very different. One may have risen steadily, while the other fell 40% before recovering. If you had needed your money during that fall, the CAGR would have been little comfort.
- The risk. A high number says nothing about how much risk was taken to get it.
- The dates chosen. Starting right after a crash, or ending right before one, changes the result a lot. Be wary of any single period, and look at several.
- Contributions. If you added or withdrew money, the CAGR between your starting and ending balances is not your return. Say you start with $10,000, add $10,000 in the last year and finish with $21,000. The formula shows healthy growth, but most of it is money you put in yourself. In these cases you need a money-weighted return, such as IRR.
- Costs and taxes. Many published figures are before these. What matters is what you keep.
How to use it well
Compare like with like. A 3-year CAGR and a 15-year CAGR do not tell you the same thing, even if the numbers match. That is CAGR’s value, since it puts different time frames in the same unit, but a short period may reflect just one good year.
Compare it to a reasonable alternative. A 6% annual return sounds fine, but it depends on what a comparable investment did over the same period. For a US stock fund, that might be a broad market index with dividends included.
Adjust for inflation. To get real growth, take inflation out. An 11% CAGR with 3% inflation is a real return of 7.77%, as we explain in how inflation affects your savings.
Do not just project it forward. Past returns do not guarantee future ones. For planning, use a cautious figure and test what a lower one would do in the compound interest calculator.
Use it beyond investing. It also works for sales, business revenue or your own salary. If you earned $50,000 ten years ago and earn $66,000 now, your pay has grown about 2.8% a year.
To estimate how fast your money would double at that rate, use the rule of 72.