CAGR, short for Compounded Annual Growth Rate, is also known by other names such as compound returns, compounded annual returns, and annualised returns.
The CAGR shows you the compounded returns that a one-time investment, invested for multiple years, has generated each year.
Example: If you invested Rs. 10,000 in stocks of a company in 2014 and those stocks are worth Rs. 20,000 today, your money has doubled and that sounds great. But how much returns did your investment of Rs. 10,000 generate each year?
That’s what our CAGR calculator will arrive at for you and in this case, it is 14.87%. You can use the CAGR to decide how well (or badly) an investment has fared.
The formula for calculating the compounded annual growth rate on an investment is to simply take the return fraction and raise it to the power of (1/n), where n is the number of years invested, and then subtract 1 to remove the principal component.
CAGR = [(Value at the end / Value at the beginning) ^ (1/n)] – 1
CAGR works on the principle of compounding. Here is a simple example of compounding:
Suppose you lend someone Rs 1 lakh in exchange for 10% interest on it for a year. At the end of the year, you get Rs 1.1 lakh (Rs 1 lakh + 10% of Rs 1 lakh = Rs 1,10,000).
Now, if you lend back the Rs 1.1 lakh for 10% interest again, at the end of the second year, you make Rs 1.21 lakh (Rs 1.1 lakh + 10% of Rs 1.1 lakh = Rs 1,21,000).
Money building on itself in this manner is what is called compounding.
However, if you lend the money for 5 years and in return your money is doubled at the end of 5 years, the total returns (absolute return) you would make on your investment over 5 years would be 100%.
But what would the annual returns be? If you were to simply divide the 100% by 5, you would get 20%, which would be what we call ‘simple returns’.
But if we apply the CAGR formula, the return would be 14.87%. What this means is that the money compounded every year at the rate of 14.87%.