What is CAGR and how it works? [ Compound Annual Growth Rate ]:

We are back again with another important topic to be known by every individual investor or trader.

In this article, we will be discussing “What is CAGR and how it Works?

Concerning this topic in further reading, you will get to know it’s the essence of why we are focusing on this content currently.

As Albert Einstein as said, “Compound interest is the eighth wonder of the world. He who understands it earns it and he who doesn’t pay it.”

You must be aware that the participation in the Stock Market has seen immense growth as the individual are focusing more on to know about the finance and working of the stock market.

Many of us are aware that CAGR is the most used word in the stock market, and we should know why this term has so much importance in the market.

So, with no further delaying, we shall begin our topic on “What is CAGR and how it works?”

Starting with the Definition,

What is CAGR?

The Full Form of CAGR is “Compound Annual Growth Rate”.

CAGR is a rate that states about the annual growth rate of an investment with over a specified period that is longer than one year.

This rate represents the most accurate and gives reliable results to calculate the returns for the individual assets, investment portfolios and many other securities whose value can rise or fall over a while.

All the investment offers the benefit of compounding that will help you double your investment and build wealth.

In simple words, CAGR shows how much a person’s investment has grown over a while with an interval of one year.

This rate calculated in terms of percentage.

Let’s now get into detail to know about the calculation of Compound Annual Growth Rate.

Calculation of CAGR

In the investments, the majority of the investors rely on the absolute returns for analysing the performance of the portfolio.

But they forget to consider the calculation of time value of money while calculating the returns.

While CAGR takes into consideration of the period for which the investors has stayed invested in the given avenue.

CAGR provide you with the approximate rate at which the investment would grow if there is no volatility.

It has often been using to measure and in comparing the past performance of the investments or to project their expected future returns.

Let’s walk down to understand the CAGR Formula:

The Compound Annual Growth Rate takes into the consideration of the ending value of the investment, the beginning value, and the number of the compounding years for calculation.

The formula for CAGR IS: 

CAGR = [(End Value) / (Beginning Value)] ([1) ⁄ (Years])-1

This is an excellent way to factor the fluctuations experienced by the assets or securities over a specific period of time.

With this, you can easily interpret the performance over a particular horizon of time.

This is an excellent way to make an eye on how the given investment has been compared to its price.

Now, we will observe the usage of the CAGR formula in finding the returns of the assets to make an informative decision about whether to make a worthy investment or not.

  • In the scenario of investing in the different investment securities like mutual funds, there is a need to find out the returns to make an informative decision about whether to make a worthy investment or not.
  • For that, we need to measure its past performance of a certain asset over a certain period of time.
  • So, CAGR is the right way to measure fund performance.

The other ways of computing the returns are:

  1. Annualized Return
  2. Trailing Return
  3. Return Since Launch

Conclusion

The crux of the topic is that CAGR is a more reliable factor to track the growth of an investment.

The reason behind this is due to the annual return rate doesn’t count the compounding factor, and that leads to overestimation.

In the end, it is useful to understand the concept of CAGR by every individual investor or trader to use this factor for deciding on the different kinds of funds.

At last, I would like to conclude the topic on “What is CAGR and how it works?” that states about its definition, importance, calculation and formula which is easy and vital to be acknowledged by every participant of the Stock Market.

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Author

Prashant Raut is a successful professional stock market trader. He is an expert in understanding and analyzing technical charts. With his 8 years of experience and expertise, he delivers webinars on stock market concepts. He also bags the ‘Golden Book of World Record’ for having the highest number of people attending his webinar on share trading.