What CAGR Actually Measures
The Compound Annual Growth Rate (CAGR) answers one specific question: if an investment had grown at a single, steady rate every year instead of its actual (often bumpy) year-to-year performance, what would that steady rate have been? It’s a smoothed average, not a description of what actually happened in any individual year.
The CAGR Formula
CAGR = (Ending Value / Beginning Value)(1/n) − 1
Where n is the number of years the investment was held. The result is usually expressed as a percentage.
Why CAGR Is Useful for Comparison
Two investments can have wildly different year-by-year returns (one volatile, one steady) yet end up at the same final value over the same period — and therefore have the identical CAGR. This makes CAGR a fair way to compare very different investments (say, a stock and a mutual fund) purely on their overall growth outcome, without getting distracted by short-term ups and downs.
What CAGR Does NOT Tell You
CAGR hides volatility entirely. An investment that went up 50% one year and down 20% the next could have the same CAGR as one that grew steadily by a modest amount every year — but the first one was clearly a much bumpier ride to sit through. CAGR is a growth-rate summary, not a risk measure, so it should never be the only number you look at before investing.
A Simple Example
If an investment grew from ₹1,00,000 to ₹1,50,000 over 5 years, the CAGR calculation tells you the single steady annual rate that would have produced that same growth — useful for comparing against, say, a fixed deposit’s known interest rate, or another fund’s CAGR over the same period.