CAGR (Compound Annual Growth Rate)
CAGR measures the annualized rate of return over a period, assuming profits are reinvested. It smooths out volatility to show the steady growth rate.
Formula
Example
An investment grows from $10,000 to $25,000 over 5 years. CAGR = (25000/10000)^(1/5) - 1 = 20.11% per year.
How to Interpret It
CAGR is best for comparing investments over different time periods. A 10-year CAGR of 12% means the investment grew at 12% per year on average, compounded.
CAGR vs. Absolute Return
Absolute return is the simple total gain: ending value minus beginning value. A $1,000 investment growing to $1,500 has an absolute return of 50%. But 50% over 1 year is excellent, while 50% over 10 years is mediocre. CAGR solves this by annualizing returns.
$1,000 → $1,500 over 3 years: Absolute return = 50%, CAGR = 14.47%
$1,000 → $1,500 over 10 years: Absolute return = 50%, CAGR = 4.14%
Same absolute return, vastly different annualized performance. Always use CAGR when comparing investments held for different periods.
Real-World Example: Volatility Hidden in CAGR
Even when two portfolios end with the same CAGR, the path can feel totally different: a smooth climb is easier to hold than a roller coaster that triggers panic-selling at the worst time.
- Investment A: +15%, +15%, +15%, +15%, +15% — perfectly smooth
- Investment B: +50%, -20%, +30%, +10%, -5% — rollercoaster
Same CAGR, vastly different experience. Investment A lets you sleep at night; Investment B might cause you to panic-sell. This is why CAGR should always be paired with volatility measures like standard deviation.
Common Mistakes
- Assuming CAGR predicts future returns: A 15% CAGR over the past 5 years doesn't mean the next 5 years will be similar. Past performance is not indicative of future results.
- Ignoring volatility: CAGR is a smoothed average that hides year-to-year swings. Two investments with the same CAGR can have very different risk profiles.
- Using CAGR for short periods: Less than 3 years is too short for meaningful CAGR analysis. A single good or bad year can distort the result.
- Comparing CAGR across different time periods without context: A 5-year CAGR during a bull market vs a 10-year CAGR spanning a recession are not directly comparable.
Pro Tips
Compare to benchmarks: Always compare your portfolio's CAGR to a relevant benchmark. The S&P 500 has historically returned ~10% CAGR. A portfolio achieving 12% CAGR with similar risk is excellent; achieving 12% with triple the volatility is less impressive.
Use CAGR alongside standard deviation: A 15% CAGR with 8% standard deviation is far superior to 15% CAGR with 25% standard deviation. The Sharpe ratio (CAGR ÷ volatility) gives you a single number for risk-adjusted comparison.
Frequently Asked Questions
Can CAGR be negative?
Yes. A negative CAGR means the investment lost value over the period. If you invested $10,000 and it became $7,000 over 3 years, the CAGR is about -11.2%. Negative CAGR is a clear signal that something went wrong with the investment thesis.
What's the difference between CAGR and average return?
Average return simply adds up yearly returns and divides by years. CAGR accounts for compounding. Example: +50% one year, -50% the next. Average return = 0%. But $100 → $150 → $75. CAGR = -13.4%. CAGR gives the true picture because it reflects compounding effects.
What's a good CAGR for a stock?
The S&P 500's long-term CAGR is about 10%. Beating 10% consistently is excellent. For individual stocks, 15-20% CAGR over 5+ years is outstanding (think Apple, Amazon). For revenue growth, 20%+ CAGR signals a high-growth company. Always compare to the relevant benchmark.