CAGR — Compound Annual Growth Rate — measures the average annual growth of an investment or metric over a multi-year period, assuming the growth compounds each year. It smooths out volatility and gives you a single annual rate that, if applied consistently, would take the starting value to the ending value over the given time frame.
The CAGR formula
The formula raises the growth ratio to the power of 1/years, which effectively "averages" the compounding. It accounts for the fact that growth builds on itself — making it more meaningful than a simple average for multi-year returns.
Worked examples
- Investment growth: You invest $10,000 and it grows to $18,000 over 5 years. CAGR = ((18,000 ÷ 10,000) ^ (1/5) − 1) × 100 = (1.8 ^ 0.2 − 1) × 100 = 12.47% per year.
- Revenue growth: A company's revenue goes from $2M to $5M in 3 years. CAGR = ((5 ÷ 2) ^ (1/3) − 1) × 100 = 35.72% per year.
- Home value: A house bought for $300,000 is worth $420,000 after 7 years. CAGR = ((420,000 ÷ 300,000) ^ (1/7) − 1) × 100 = 4.93% annual appreciation.
CAGR vs. average annual return
A simple average can be misleading. If an investment returns +50% in year 1 and −33% in year 2, the simple average is +8.5%. But the actual result: $100 → $150 → $100. Your money is back where it started — the true CAGR is 0%. CAGR always reflects the actual end-to-end growth, making it the better metric for comparing investments.
When to use CAGR
- Comparing investments: A stock fund with a 3-year CAGR of 11% vs. a bond fund at 4% — apples-to-apples comparison.
- Business planning: Projecting future revenue based on historical growth rates.
- Real estate: Measuring how fast property values have appreciated in a given market.
- Personal finance: Evaluating whether your savings are growing fast enough to meet long-term goals.
Limitations of CAGR
CAGR only looks at the start and end values — it ignores what happened in between. An investment that crashed 50% in year 2 and then recovered looks identical to one that grew steadily. For a fuller picture, consider CAGR alongside other metrics like standard deviation (volatility), maximum drawdown, and Sharpe ratio. CAGR is best for long-term trend analysis, not for evaluating short-term risk.