Mastering the Formula- How to Calculate the Compound Annual Growth Rate (CAGR)
How do I calculate compound annual growth rate (CAGR)? This is a question that often arises when analyzing the performance of investments, businesses, or any other financial metrics over time. CAGR is a useful metric as it provides a clear and concise way to understand the average annual growth rate of an investment or asset over a specific period. In this article, we will explore the formula for calculating CAGR and provide you with a step-by-step guide to help you determine the growth rate of your investments or other financial metrics.
Compound annual growth rate, or CAGR, is the rate at which an investment grows over a specific period of time, taking into account the compounding effect of reinvesting the returns. It is important to note that CAGR is not the actual return on investment, but rather a measure of the average annual growth rate. This makes it a valuable tool for comparing the performance of different investments or assets over time.
Calculating CAGR involves the following steps:
1.
Determine the initial value of the investment or asset.
2.
Determine the final value of the investment or asset after the specified period.
3.
Determine the number of years over which the investment or asset has grown.
4.
Use the following formula to calculate CAGR:
CAGR = [(Final Value / Initial Value)^(1 / Number of Years)] – 1
5.
Convert the result to a percentage by multiplying by 100.
Let’s take an example to illustrate the calculation of CAGR. Suppose you invested $10,000 in a stock five years ago, and today, the value of your investment is $20,000. To calculate the CAGR, you would follow these steps:
1.
Initial Value = $10,000
2.
Final Value = $20,000
3.
Number of Years = 5
4.
CAGR = [(20,000 / 10,000)^(1 / 5)] – 1 = 1.1487 – 1 = 0.1487
5.
CAGR = 0.1487 100 = 14.87%
This means that your investment has grown at an average annual rate of 14.87% over the past five years.
It is important to note that CAGR assumes that the investment is reinvested annually, and that the initial investment is not adjusted for inflation. Therefore, it is essential to consider these factors when using CAGR to evaluate the performance of your investments.
In conclusion, calculating compound annual growth rate is a straightforward process that can help you understand the average annual growth rate of your investments or assets. By following the steps outlined in this article, you can easily determine the CAGR and make more informed decisions about your financial future.
