Compound Annual Growth Rate (CAGR)
The mean annual growth rate of an investment over a specified period of time longer than one year, assuming profits are reinvested.
The Compound Annual Growth Rate (CAGR) is one of the most accurate ways to calculate and determine returns for anything that can rise or fall in value over time.
Unlike absolute returns, which simply tell you how much money you made in total, CAGR smooths out the volatility of an investment to give you a single, steady annualized percentage rate. It essentially answers the question: "If this investment grew at a perfectly steady rate every single year, what would that rate be?"
The Formula
The mathematical formula for calculating CAGR is:
CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) - 1
Real-World Example
Suppose you invest ₹10,000. In Year 1, it grows to ₹15,000 (a 50% gain). In Year 2, it drops to ₹12,000 (a 20% loss). In Year 3, it grows to ₹16,000 (a 33% gain).
Calculating the average of those annual percentages gives you a misleading number. Instead, by using the CAGR formula:
CAGR = (16,000 / 10,000)^(1/3) - 1 = 16.96%
Your investment grew at a compounded rate of 16.96% per year over the 3-year period. CAGR is the gold standard for comparing the historical performance of different mutual funds, stocks, or business revenues.