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Length of Investment in Years

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CAGR

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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.

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CAGR represents the rate at which something would need to grow each year to reach its ending value from its beginning value over a given time period, assuming the growth compounds annually. It smooths out volatility and provides a single percentage that represents consistent annual growth

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.

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.

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The Compound Annual Growth Rate (CAGR) is a powerful financial metric that measures the average annual growth rate of an investment or business over a specified period. It provides a standardized way to express the rate of return or growth, making it invaluable for various financial analyses, especially when comparing diverse investments or business performances across different timeframes.

CAGR is particularly useful when growth rates fluctuate significantly year-to-year. In such cases, a simple average wouldn't accurately reflect the true overall growth. By smoothing out these fluctuations, CAGR offers investors and analysts a clearer understanding of the consistent, year-on-year growth rate of an investment.

Here are common scenarios where CAGR is applied:

Investment Performance: CAGR calculates the smoothed annual return of an investment over a set period, enabling investors to compare the effectiveness of different investments, regardless of their varying holding periods.

Business Growth: Companies utilize CAGR to track the growth of key metrics like revenue, profit, or other performance indicators over time, offering insights into their operational expansion.

Market Analysis: Analysts employ CAGR to evaluate the historical performance of financial markets, including stock indices, or commodity prices, revealing long-term trends.

Projected Growth: Based on historical performance, CAGR can be used to estimate the potential future growth of an investment or business, aiding in forecasting.

Investment Planning: For long-term financial goal setting, CAGR helps in projecting the potential future value of investments, supporting strategic financial decisions.

In essence, CAGR is a vital tool for understanding and comparing the growth of investments or businesses over time, offering a more accurate and representative view of performance across various periods.

• Provides a clear, single number for comparison
• Accounts for compounding effects
• Smooths out year-to-year volatility
• Useful for comparing different investments or business metrics

• Assumes steady growth (which rarely happens in reality)
• Doesn't show volatility or risk
• Can be misleading if there are significant fluctuations
• Only shows average growth, not the actual path

CAGR is particularly valuable for investors and analysts when comparing the performance of different investments or evaluating long-term business trends.