CAGR (Compound Annual Growth Rate)

Compound Annual Growth Rate (CAGR) is the rate at which an investment would have grown if it grew at a steady rate annually, with returns compounded each year. It's the single most useful number for comparing the long-term performance of investments because it smooths out volatility and gives you one clean annualized figure.

The CAGR Formula: CAGR = (Ending Value / Beginning Value)^(1 / Years) − 1

Example:

• You invest $10,000. After 5 years, it's worth $16,105.
• CAGR = ($16,105 / $10,000)^(1/5) − 1 = 1.6105^0.2 − 1 = 0.10 = 10% per year
• This means your investment grew as if it earned exactly 10% each year, compounded.

Why CAGR Is More Useful Than Simple Average: Imagine an investment that gains 100% in Year 1 and loses 50% in Year 2.

• Simple average return: (100% + -50%) / 2 = 25% per year (misleading!)
• CAGR: Start $10,000 → $20,000 → $10,000. CAGR = ($10,000/$10,000)^(1/2) − 1 = 0% (accurate — you made nothing)

CAGR reveals the true growth rate. The simple average was 25% but you actually broke even. This difference is called volatility drag.

Common CAGR Benchmarks:

• S&P 500 historical CAGR (1926–2023): ~10% nominal, ~7% after inflation
• Berkshire Hathaway CAGR (1965–2023): ~19.8% (vs. S&P 500's ~9.9%)
• Real estate (US, 1928–2023): ~4.5% nominal

Where CAGR Is Used:

• Evaluating fund/stock performance over time
• Projecting future portfolio values
• Comparing business revenue/earnings growth
• Assessing economic growth (GDP CAGR)

Limitation: CAGR assumes smooth growth — it doesn't tell you how bumpy the ride was (that requires standard deviation or Sharpe ratio).