The Compounded Annual Growth Rate (CAGR) is the rate of return required for an investment to grow from its beginning balance to its ending balance over a specified period, assuming profits are reinvested at the end of each period. It provides a smoothed annual growth rate, offering a clearer picture of an investment's performance over time and allowing for accurate comparisons between different investments.
To calculate CAGR, use the formula:
CAGR=(EV/BV)1/n−1
Where:
CAGR differs significantly from the Simple Growth Rate in that it accounts for the time value of money, compounding the returns each year. In contrast, the Simple Growth Rate calculates the total percentage increase divided by the investment period, ignoring the effects of compounding. CAGR offers a more detailed and accurate portrayal of growth, making it superior for comparing the performance of investments over multiple periods.
CAGR is extensively used in business strategy for various purposes:
The Compound Annual Growth Rate (CAGR) significantly impacts investment decisions by providing a clearer picture of an investment's performance over time. This allows investors to compare different investment options and make informed choices. However, it's essential to remember that CAGR does not account for investment risk or volatility.
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