CAGR Definition: Understanding Compound Annual Growth Rate

CAGR, or Compound Annual Growth Rate, is a financial metric used to measure the mean annual growth rate of an investment over a specified period of time, assuming the profits are reinvested each year. The CAGR definition helps investors assess how consistently their investments grow over time, especially in cases where growth rates may fluctuate from year to year.

The formula for calculating CAGR is:

$$CAGR = \left( \frac{{\text{Ending Value}}}{{\text{Beginning Value}}} \right)^{\frac{1}{\text{Number of Years}}} - 1$$

This method smoothens out the volatility of returns, offering a clear picture of an asset's performance over time. For example, if an investment grows from $10,000 to $20,000 over five years, the CAGR would reflect the steady annual growth rate that would lead to this outcome.

CAGR is widely used for comparing the performance of investments such as mutual funds, stocks, or even businesses. Unlike simple annual returns, it accounts for compounding, making it a more accurate measure of growth over time. Understanding the CAGR definition helps investors make informed decisions, especially when evaluating the long-term potential of different investment options.