CAGRCompound Annual Growth Rate

The compound annual growth rate (CAGR) answers one question: at what constant yearly pace would an investment have to grow to get from its starting value to its ending value over a given time?

Example: 100,000 grows to 121,000 in two years. The simple return is 21%, but CAGR is 10%, because 10% compounded twice gives 21%. Dividing 21% by two years (10.5%) overstates the result because it ignores compounding.

CAGR vs simple return and TWR

• The simple return shows the total growth over the whole period, without converting it to a yearly rate.
• CAGR converts growth into a constant yearly rate, but only looks at the starting and ending values.
• Annualized TWR equals CAGR when there are no deposits or withdrawals. When there are, TWR neutralizes them, while a CAGR based on portfolio values counts top-ups as gains.

That is why CAGR describes a single investment without cash flows well, such as the growth of an index, a company’s revenue or a one-off fund purchase. For a portfolio with regular deposits, use TWR (the investments’ result) or MWR (the investor’s result).

CAGR smooths out the path: an investment that grew steadily and one that first halved and then more than recovered can share the same CAGR. Volatility and drawdown describe what happened along the way.