Formula to Calculate CAGR (Compounded Annual Growth Rate)

The formula can also be expressed by adding one to the absolute returnAbsolute ReturnAbsolute return refers to the percentage of value appreciation or depreciation of an asset or fund over a certain period. Such assets include mutual funds, stocks and fixed deposits.read more on investment (ROI), then raising the result to the power of reciprocity of the tenure of investment and then finally subtracting one.

where Absolute ROI = (Ending value – Beginning value) / Beginning value

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Calculation of CAGR (Step by Step)

Examples

Example #1

Let us take an example of David, who invested $50,000 in a portfolio on Jan 1, 2015, and the following portfolio return has been outlined below:

  • Firstly, determine the beginning value of the investment or the money that was invested at the start of the investment tenure. Next, determine the final value of the investment at the end of the tenure of investment or the ending value. Next, determine the tenure of the investment, i.e., number years from the start of the investment to the end of the same. Next, divide the ending value of the investment by the beginning value and then raise the result to the power of reciprocity of the tenure of investment. Finally, subtract from the result and express in percentage terms to derive the compounded annual growth rate formula, as shown above.

  • On Jan 1, 2016, the value of the portfolio stood at $60,000On Jan 1, 2017, the value of the portfolio was $73,000On Jan 1, 2018, the value of the portfolio was $70,000On Jan 1, 2019, the value of the portfolio was $85,000

Based on the given, determine the yearly return and the CAGR for David’s investment portfolio.

Use the following data for the calculation of CAGR.

Return for the 1st year

  • Return for 1st year = [(Ending value / Beginning value) – 1] * 100%= [($60,000 / $50,000) – 1] * 100%= 20.00%

Return for 2nd year

  • Return for 2nd year = [($73,000 / $60,000) – 1] * 100%= 21.67%

Return for 3rd year

  • Return for 3rd year = [($70,000 / $73,000) – 1] * 100%= -4.11%

Return for 4th year

  • Return for 4th year = [($85,000 / $70,000) – 1] * 100%= 21.43%

Now, let us do the calculation of the CAGR in excelCAGR In ExcelCAGR or compound annual growth rate calculates the growth rate of a particular amount annually. We make categories in tables and apply the formula to calculate CAGR. Formula = (Ending balance/Starting balance)˄(1/Number of years) – 1.read more based on the given information,

  • CAGR = [($85,000 / $50,000) 1/4 -1] * 100%

CAGR will be –

  • CAGR = 14.19%

Therefore, the above example shows how CAGR encapsulates all the growth and de-growth during the investment period and provides an average annual growth rate during the investment tenure.

Example #2

Let us take an example of an equity portfolio that has value growth such that the absolute return over the period of five years stood at 57%. Do the calculation for the CAGR of the portfolio.

Therefore, the calculation of CAGR of the portfolio can be done as,

  • CAGR = [(1 + Absolute ROI) 1/ Number of years – 1] * 100%= [(1 + 57%) 1/5 – 1] * 100%

  • CAGR = 9.44%

Therefore, the CAGR of the equity portfolio after five years stood at 9.44%.

CAGR Calculator

You can use the following CAGR Calculator.

Uses of CAGR

It is important for the analyst to understand the concept of the compounded annual growth rate because it can be used to calculate the average growth of an investment. Under certain circumstances, the market becomes volatile, and as such, the year-to-year growth of an investment may appear uneven and erratic. In such a case, the CAGR helps in smoothing the erratic growth rates that are expected due to market volatility and inconsistency.

Another use of the CAGR equation is that it can be used for comparison of investments of different types. Nevertheless, the CAGR has its own drawback that by smoothening the erratic returns on investment, the CAGR conceals from the investor the fact of how risky or volatile the portfolio has been during its investment tenure. However, despite the drawback, the CAGR remains a very useful performance indicator for investors and analysts.

This article has been a guide to CAGR Formula. Here we learn how to calculate the compounded annual growth rate of the portfolio with examples and a downloadable excel template. You can learn more about financing from the following articles –

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  • read moreFormula of Effective Annual RateCalculation of Growth RateCalculation Of Growth RateThe Growth rate formula is used to calculate the annual growth of the company for a particular period. It is computed by subtracting the prior value from the current value and dividing the result by the prior value.read moreFormula to Calculate Interest RateFormula To Calculate Interest RateAn interest rate formula is used to calculate loan repayment amounts as well as interest earned on fixed deposits, mutual funds, and other investments. It is also used to calculate credit card interest.read more