Compound Annual Growth Rate (CAGR): 5 Key Things Investors Must Know

The Compound Annual Growth Rate (CAGR) is a parameter used to calculate the annualised growth rate of an investment or metric during a specific period. It’s one of the most convenient methods for determining returns on individual assets, investment portfolios, and anything else that can rise or decline in value over time.

CAGR is essential for evaluating investment opportunities and the past performance of an investment. It enables you to compare various investments consistently and make accurate decisions.

How to calculate the Compound annual growth rate? Here’s the formula:

CAGR = (Ending value/beginning value) ^ (1/No. of periods) -1

*Ending value is the value of investment at the end of the investment period.

*Beginning value is the value of investment at the beginning of the investment period

*The number of periods is the time for how many years you’ve invested.

Important things investors must know about CAGR:

CAGR refers to the average annualised rate at which the value of an investment (stocks, funds etc.) changes over time.

If the price of a stock rises from Rs 200 to Rs 242 in two years, its CAGR will be 10 per cent. However, the annual rate of growth will vary between financial periods due to market volatility. Thus, the stock price doesn’t have to move from Rs 200 to Rs 242 at a constant speed. It might have risen to Rs 280-320 in the first year and then fallen to Rs 242. The annual rate of growth will vary between financial periods due to market volatility.

Given the starting and ending values, its CAGR will remain at 10% per year. As a result, CAGR could cover up turbulent conditions in the interim and give a picture of consistent growth.

Instead of believing that the rate will remain constant every year, investors who use advertised CAGR should also take risk factors into account.

It’s important to understand that CAGR is less reliable for short investment periods. CAGR provides accurate estimates of the annualised rate of growth for investments. When calculating, it is preferable to utilise longer periods to ensure accurate results.