Compound Annual Growth Rate (CAGR)
Candlefocus EditorTo calculate CAGR, the initial investment is divided by the final asset value and the result is then raised to a certain power that corresponds to the number of years in which the investment was held. For instance, to find the CAGR of a 3-year investment, the divisor would be 3, yielding the following formula: (Final Value/Initial Value)^(1/3)-1.
CAGR is a good way of looking at total return as it reflects the net amount of growth for a given set of investments. This can give a more realistic view of performance since it accounts for the reinvestment of income such as interest and dividends over the investment period. Moreover, CAGR is useful when analyzing investments in the stock market. It can be used to compare the performance of a stock to that of an index, other stocks in its peer group, or even a portfolio.
Although the CAGR gives an indication of the absolute rate of growth, it does not take into account the volatility or risk associated with the investments. For that, investors need to look at other metrics such as standard deviation or Sharpe ratio.
In summary, the compounded annual growth rate (CAGR) is a helpful way to measure the returns of an investment and compare it to other investments without the risk of local fluctuations affecting the result. CAGR is a straightforward calculation that makes it easy to compare returns across different investments, though it does not reflect the level of risk involved. It is important to be aware of the limitations of CAGR and consider other measures when deciding where to invest.