Compound Annual Growth Rate (CAGR) measures your investment's annual growth rate over a specific period, accounting for compounding effects. It shows the steady rate of return you would need each year to reach your current investment value from your initial investment.
How to calculate CAGR
The CAGR formula is:
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CAGR = (Ending Value ÷ Beginning Value)^(1/Number of Years) - 1
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If you invested ₹10,000 in a mutual fund and it grew to ₹16,105 after 5 years:
- Calculate the growth ratio ₹16,105 ÷ ₹10,000 = 1.6105
- Apply the time period (1.6105)^(1/5) = 1.10
- Convert to percentage 1.10 - 1 = 0.10 or 10%
Your investment's CAGR is 10%, meaning it grew at an average rate of 10% annually over 5 years.
Why CAGR matters
CAGR provides a more accurate picture of your investment performance than simple average returns because it accounts for compounding. For example, if your fund returned +20% in year 1, -10% in year 2, and +15% in year 3, the simple average would be 8.33%. However, CAGR would show the actual compounded growth rate, giving you a clearer understanding of your investment's true performance over time.
Did you know? CAGR assumes you invested the entire amount at the beginning, while XIRR (Extended Internal Rate of Return) considers the actual timing of each investment, making it more accurate for SIP returns.