Compound annual growth rate, or CAGR, is the mean annual growth rate of an investment over a specified period of time longer than one year. It represents one of the most accurate ways to calculate and determine returns for individual assets, investment portfolios and anything that can rise or fall in value over time.
CAGR is a term used when investment advisors tout their market savvy and funds promote their returns. But what does it really show?
What Is CAGR?
The CAGR is a mathematical formula that provides a "smoothed" rate of return. It is really a pro forma number that tells you what an investment yields on an annually compounded basis — indicating to investors what they really have at the end of the investment period.
For example, let's assume you invested $1,000 at the beginning of 2016 and by year-end your investment was worth $3,000, a 200 percent return. The next year, the market corrected, and you lost 50 percent — ending up with $1,500 at the end of 2017.
What was the return on your investment for the period? Using average annual return does not work. The average annual return on this investment was 75 percent (the average of 200 percent gain and 50 percent loss), but in this two-year period you ended up with $1,500 not $3,065 ($1,000 for two years at an annual rate of 75 percent). To determine what your annual return was for the period, you need to calculate the CAGR.
Source : Investopedia