Your portfolio was up 30% one year, down 10% the next, then up 15%. What's your actual return? Simple averaging gives you 11.7%—but that's wrong. You need CAGR.

What is CAGR?

CAGR stands for Compound Annual Growth Rate. It tells you the constant annual return that would take you from your starting value to your ending value over a specific time period.

Think of it as "smoothed" growth. Real investments bounce around year to year. CAGR answers: "What steady annual return would have gotten me to the same place?"

The CAGR Formula

CAGR = (Ending Value / Beginning Value)^(1/n) - 1

Where:

• Ending Value = Final investment value
• Beginning Value = Initial investment
• n = Number of years

Example Calculation

You invested $10,000 five years ago. It's now worth $16,500.

CAGR = ($16,500 / $10,000)^(1/5) - 1

CAGR = (1.65)^0.2 - 1

CAGR = 1.1052 - 1

CAGR = 10.52%

Your investment grew at an average rate of 10.52% per year.

Why Simple Averages Don't Work

Let's see why CAGR matters with a dramatic example:

Year 1: Portfolio grows from $100 to $200 (+100%)

Year 2: Portfolio drops from $200 to $100 (-50%)

Simple average return: (100% + -50%) / 2 = 25%

But wait—you started with $100 and ended with $100. Your actual return is 0%.

CAGR = ($100 / $100)^(1/2) - 1 = 0%

CAGR gets it right because it accounts for compounding. That 50% loss in year 2 wipes out the 100% gain in year 1 because percentages compound multiplicatively, not additively.

CAGR vs Other Return Metrics

CAGR vs Average Annual Return

Average returns are always equal to or higher than CAGR. The gap between them indicates volatility.

CAGR vs Total Return

• Total Return: Shows percentage gain from start to end
• CAGR: Annualizes that gain for easy comparison

A 60% total return over 10 years sounds good. But CAGR reveals it's just 4.8% annually—below savings account rates in some environments.

CAGR vs IRR

• CAGR: Works for lump-sum investments
• IRR: Handles multiple cash flows (contributions, withdrawals)

If you made a single investment and let it grow, CAGR is perfect. If you added or withdrew money throughout, you need IRR.

Real-World CAGR Examples

S&P 500 Historical Returns

The S&P 500's performance from different starting points:

Starting point matters enormously. Someone who started in 2000 (dot-com peak) experienced very different returns than someone who started in 2010 (post-crisis bottom).

Comparing Investments

Investment A: $10,000 → $25,000 over 8 years

Investment B: $10,000 → $22,000 over 6 years

Investment A total return: 150%

Investment B total return: 120%

Investment A looks better, right? Let's check CAGR:

• Investment A CAGR: (2.5)^(1/8) - 1 = 12.1%
• Investment B CAGR: (2.2)^(1/6) - 1 = 14.0%

Investment B actually grew faster annually—it just had less time.

The Limitations of CAGR

Ignores Volatility

Two investments could have identical CAGRs but very different risk profiles:

Investment A: Steady 10% every year

Investment B: +30%, -15%, +25%, -5%, +15%

Both might produce similar ending values, but Investment B was a roller coaster. CAGR doesn't capture the stomach-churning drops.

Ignores Interim Cash Flows

CAGR only considers starting and ending values. If you added $50,000 midway through, CAGR doesn't account for that contribution. Use IRR for portfolios with ongoing investments.

Assumes Reinvestment

CAGR assumes all gains are reinvested. If you withdrew dividends or profits, your actual experience differs from the CAGR.

Historical, Not Predictive

A stock's 15% CAGR over 10 years doesn't mean it will return 15% next year. Past performance doesn't guarantee future results.

Using CAGR Effectively

Comparing Investments Over Different Time Periods

CAGR is essential for fair comparisons. A 5-year investment and an 8-year investment can only be compared properly using annualized returns.

Evaluating Fund Managers

Did that hedge fund really outperform? Compare their CAGR to a relevant benchmark over the same period.

Setting Realistic Goals

Want to turn $100,000 into $500,000? At 8% CAGR, that takes about 21 years. At 12% CAGR, about 14 years. CAGR helps you set achievable targets.

Understanding Investment Marketing

Funds love to cherry-pick periods that make them look good. "Up 200% since 2010!" sounds impressive until you calculate the CAGR is 11.6%—good, but not spectacular.

CAGR Quick Reference

To double your money:

• At 5% CAGR: ~14.4 years
• At 7% CAGR: ~10.3 years
• At 10% CAGR: ~7.3 years
• At 12% CAGR: ~6.1 years

Historical benchmarks:

• S&P 500 long-term: ~10-11% CAGR
• Bonds: ~5-6% CAGR
• Real estate: ~8-10% CAGR (varies by market)

Key Takeaways

• CAGR = (Ending Value / Beginning Value)^(1/n) - 1
• It measures the smoothed, annualized return of an investment
• Simple averages overstate returns because they ignore compounding
• CAGR allows fair comparison across different time periods
• Limitations: ignores volatility, interim cash flows, and doesn't predict the future
• Use CAGR for lump-sum investments; use IRR for portfolios with ongoing contributions

CAGR cuts through the noise of volatile year-to-year returns to show you what actually happened to your money. It's the clearest way to measure whether your investments are truly performing—and how they stack up against alternatives.