Enter the cost of your investment and the date you incurred this cost, followed by the proceeds of disposing of your investment and the date you received these proceeds.
When using a saving account or a guaranteed investment certificate (GIC), we are told an interest rate, and when investing in bonds or in money market funds, we calculate the yield. The interest rate or yield gives us a clear picture of how our money will grow over time.
In contrast, when we invest in stocks, we are unsure how the price will change, and even the dividend of the best dividend stocks may vary by an undetermined amount. Similarly, when investing in real estate, we expect its price to rise, but it is uncertain how much it will increase or even if it will grow.
To compare different investments together, we should calculate quantities (parameters) capable of giving us a clear sense of the growth rate of that investment. In the case of savings accounts and investment-grade bonds, these parameters are interest rate and yield. In the case of junk bonds, we need to discount the yield by the likelihood of default.
For more complicated (uncertain) investments, compounded annual growth rate (CAGR), internal rate of return (IRR) and money-weighted rate of return (MWRR) are used similar to yield or interest rate.
CAGR is the annual rate of return which enables an investment to reach its final value. It is suitable for judging the performance of investments containing only one purchase (investment) and one disposition. In other words, CAGR is appropriate when only one positive and one negative cash flow exists.
This formula defines compounded annual growth rate (CAGR):
CAGR = (Final value of investment/Initial value of investment)(1/n).
Where n is the investment period in years.
Compounded Annual Growth Rate (CAGR) is a measure used to calculate the smoothed annual growth rate over a specified period. It is calculated by considering an investment's initial and final value and the period over which it has grown, assuming that the growth rate is constant.
The formula for CAGR is
CAGR = (Ending Value / Beginning Value)(1 / Number of Years) - 1.
For example, if an investment has an initial value of $100,000 and grows to $150,000 over a period of 5 years, the CAGR would be:
CAGR = ($150,000 / $100,000)(1/5) - 1 = 8.4%
In other words, on average, the investment grew by 8.4% per year over the 5-year period.
CAGR is often used to compare the performance of different investments or to evaluate a company's or market's historical growth rate. It is helpful because it considers the effect of compounding, which means that the returns earned in each year are reinvested and generate additional returns in subsequent years.
CAGR is a financial metric used to measure the annual growth rate of an investment or business over a specific period of time. CAGR is commonly used in various financial analyses to provide a standardized way of expressing the rate of return or growth, especially when comparing different investments or business performance over different time frames.
CAGR is particularly useful in situations where there are significant fluctuations in growth rates over the years, and a simple average would not accurately represent the overall growth. By using the compound annual growth rate, investors and analysts can gain a better understanding of the steady, year-on-year growth rate of an investment.
Here are some common scenarios where CAGR is used:
Investment performance: CAGR can be used to calculate the smoothed annual return of an investment over a certain period. This allows investors to compare the performance of different investments, even if they have different holding periods.
Business growth: Companies may use CAGR to measure the growth of their revenue, profit, or other key performance indicators over a specific period, providing insights into their growth rate.
Market analysis: CAGR is employed to evaluate the historical performance of financial markets, such as stock market indices, bond yields, or commodities prices.
Projected growth: CAGR can also be used to estimate the future growth of an investment or business based on historical performance.
Investment planning: When planning for long-term financial goals, CAGR can help in projecting the potential value of investments over time.
CAGR is a valuable tool for understanding and comparing the growth of investments or businesses over time, providing a more accurate representation of performance across different periods.