If you have invested money in something and want to make an estimate of your gain, then you will find our CAGR calculator extremely useful. This tool uses the CAGR formula to generate calculations. It’s all about Compound Annual Growth Rate (we will explain it in detail later).
In this article, you will also find explanations of how to calculate your growth rate (it plays a critical role in determining the profit), what’s compound interest, how to calculate a simple growth rate, and much more. You will also learn how to utilize the CAGR calculator when determining the initial and the end values of your investment.
With all the facts at your fingertips, it will be easier for you to choose the right savings account and decide on where to keep your savings. Moreover, the CAGR calculator can make your life a whole lot easier when planning capital investments.
Compound Interest: What’s That?
Before digging a bit deeper into compound annual growth rate, let’s shed some light on compound interest. It will help you get a better understanding of the CAGR calculator. So, what is it?
The compound interest is the interest that is calculated on the initial principal and also on the accumulated interest of previous periods. The amount of compound interest depends on the frequency and timing of compounding as well. Here’s the compound interest formula:
FV = PV * (1 + r/m) ^ m * t
FV = the future investment value
PV = the initial balance
m = compounding frequency
r = the yearly interest rate
t = it shows how many years the capital is invested for
In essence, the “r” in this formula is the CAGR if m = 1, i.e. when you compound the interest once a year.
What Is Compound Annual Growth Rate (CAGR)?
CAGR is intended to describe the rate that would cause investment to grow given that it would increase at an identical rate each year throughout the entire period of investment. It should be noted that we assume that the profits will be invested again after every year.
In other words, CAGR is a compound rate of return that calculates the annual growth of an investment over a specific period. It can be calculated for any number of periods, but most often it is calculated for periods between one and ten years.
How Compound Annual Growth Rate (CAGR) Can Be Used?
Keep in mind that the CAGR is just a representational number; it’s not an actual return rate. While this kind of performance isn’t likely in reality, you can still use it to smooth your investment returns and make them more understandable than alternative methods.
The CAGR can also help you estimate the growth of your investment in a certain year. Here are additional uses of Compound Annual Growth Rate:
- Comparing Investments – It can help you compare various types of investment and see which one is most profitable.
- Tracking Performances – Many investors also use the CAGR to keep track of the business performances of their companies.
- Detecting Strengths and Weaknesses – The CAGR allows you to identify the strengths and weaknesses of different business activities.
CAGR Formula
The CAGR formula can be expressed as:
CAGR = (FV / IV) ^ (1 / No. of years) – 1, or
CAGR = [(Ending Value / Beginning Value) 1/n)] – 1
- FV – Future (ending) value of an investment
- IV – Initial (beginning) value of an investment
- n – Number of years (investment period in years)
NOTE: The result you get can be multiplied by 100 if you want to express it as a percentage.
As you can see, this formula is dependent on 3 variables: the number of years as well as the initial and the final value. So you only need to know these three values when calculating the CAGR. We will provide an example to help you understand how to calculate CAGR on your own.
CAGR Calculation Example
If the beginning value of an investment is $10,000, for example, and the end value is $15,000 in 3 years (from February 2019 to February 2022), then CAGR = (15,000/10,000) (⅓) – 1 * 100% = 14.47%.
To get a better idea of how it works, we will break it down by years:
- After the 1st year (on February 2020), you had $10,000 * (1 + 0.1447) = $11,447. So, your investment grew to $11,447 in 12 months. Let’s assume you kept that money in your bank account.
- After the 2nd year (on February 2021), you had $11,447 * (1 + 0.1447) = $13,103. Once again, this amount will be kept in your account.
- After the 3rd year (on February 2022), you had $13,103 * (1 + 0.1447) = $15,000. In our example, it’s the final or end value of the investment, meaning your investment grew by $5,000 in three years.
CAGR Pros and Cons
Pros
- It allows you to calculate your ROI accurately, especially when it tends to fall and increase in value over the period of investment.
- CAGR helps in comparing profits from investments. It lets investors compare their investments over a variety of time frames.
- This is also a good way to check if the risk premium is high.
Cons
- It doesn’t allow you to estimate investment profitability with outflows and inflows throughout the period of investment.
- The investment risk isn’t taken into account.
- CAGR does not reflect the market volatility or inconstancy of the investment value.
FAQs
Can the Compound Annual Growth Rate be Negative?
Yes, it can. If your CAGR is negative, that means you’ve lost money over time.
What’s a Good CAGR?
It depends on different factors, but it’s generally evaluated using investment risk and opportunity cost. As a good rule of thumb, a CAGR of 5-10 percent in sales revenue is considered good for most companies.
For instance, if a business grew by 27% so that the CAGR is 31% on average, then the outcomes appear to be lackluster. However, if the growth rate is lower, like 8% or 12%, then the CAGR could be exceptional.