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Investors and financial planners frequently calculate CAGR. CAGR is the short form for ‘Compound Annual Growth Rate’. It expresses the growth of an investment concerning a certain period. It is important to know how to calculate CAGR to assess how an investment has grown. CAGR is useful because investments might grow at different rates from year to year. In this guide, we will understand CAGR meaning and how to calculate it in a few simple steps. Whether you are a novice with no financial background or knowledge, this comprehensive guide will understand and calculate CAGR with ease.
Page Contents
What is the Meaning of CAGR?
CAGR stands for the ‘Compound Annual Growth Rate’ of an investment. The calculation takes into account the beginning value, ending value, and the period of the investment. CAGR indicates how much an investment has grown over a specified number of years (assuming the investment was growing steadily throughout each year).
Formula for CAGR:
CAGR= (FV / PV) 1 / n – 1
Here:
FV = Future value is the value at the end of the period.
PV = Present value is the value at the start of the period.
N = Number of years of investment.
Step-by-Step Guide to Calculate CAGR
There are a few steps involved when calculating CAGR; let us break down the steps for easy understanding:
Step 1: Find the Beginning Value
The first step is taking note of the value of the investment at the beginning of the investment period.
Step 2: Find the Future Value
The next step is to find the future value of the investment at the end of the given time period.
Step 3: Determine the Time Period
Determine how many years have passed between the present value and the future value.
Note: If the time period is not full years, convert it to a decimal numerically. So, six months would reflect a 0.5 period.
Step 4: Apply the Formula
Now, substitute the present value, the future value, and the time period into the CAGR formula.
Step 5: Find the Result
After inputting the values in the CARG formula and finding the CAGR value, convert that value in percentage. For instance, a CAGR result of 0.1 states the growth rate is 10% per year.
Example Calculation of CAGR
Let us learn CAGR with an example:
Present Value of Investment (PV) = 6000
Future Value of Investment (FV) = 18000
Number of Years of Investment (n) = 4 years
Using Formula: CAGR= (FV / PV) 1 / n – 1
CAGR= (18000 / 6000) 1 / 4 – 1
CAGR= (3) 1 / 4 – 1
CAGR= 1.316 – 1
CAGR= 0.316
Therefore, in percentage, CAGR= 31.6%
Why is CAGR Useful?
CAGR is a very useful financial tool; it simplifies the analysis of the growth of investment over time. Investments often do not grow at a constant rate; they experience rises and falls over time. Some years will be years of high growth, while other years may face low or no growth at all.
With CAGR, the investor can easily smooth out these ups and downs to arrive at a single annual growth rate. This financial tool makes it a lot easier to compare different investments or assess past performances of the investment.
However, investors need to understand that CAGR does not account for investment risk and market fluctuations over the investment period. It only gives an estimated result assuming that the investment gains a constant return over a specified period of time.
Additional Tips for Beginners
Here are a few tips that every beginner and even experienced investor should consider when calculating a CAGR:
- Use an online financial calculator to save time and avoid manual errors.
- Always ensure the investment values before doing any calculation.
- Investors should remember that CAGR does not reflect the risks or fluctuations of the investment.
Conclusion
CAGR is a very helpful financial tool when it comes to the analysis of how an investment matures over time. It gives a clear and standardised method for comparing different investments against each other over a certain period of time. By understanding the EMI meaning and the guidelines for calculating CAGR, beginners can find the value of CAGR without difficulty. However, investors need to keep in mind that CAGR doesn’t speak about risk and market fluctuations. Lastly, by having a complete understanding of CAGR, its meaning, formula, and uses, investors are more likely to make informed financial decisions.
