What Is CAGR?
CAGR (Compound Annual Growth Rate) is the mean annual growth rate of an investment over a specified period longer than one year. It represents the rate at which an investment would have grown if it grew at a steady rate every year. CAGR smooths out volatility to show consistent annual performance.
CAGR Formula
CAGR = (Ending Value / Beginning Value)^(1/n) - 1, where n is the number of years. For example, if $10,000 grows to $25,000 in 5 years: CAGR = (25000/10000)^(1/5) - 1 = 20.11%. This means the investment grew at an equivalent steady rate of 20.11% per year.
CAGR vs Average Return
Average return simply averages annual returns, which can be misleading. If an investment goes up 100% then down 50%, the average return is +25%, but CAGR is 0% (you're back where you started). CAGR reflects actual growth.