What is Compound Annual Growth Rate (CAGR)?

The Key To Wealth Creation if Investors Reinvest(Hold Long-Term)

CAGR stands for Compound Annual Growth Rate and is the measure of an investment’s annual growth rate from the beginning investment balance to the end balance. This is assuming that profits are reinvested at the end of each year to the balance during the timespan of the investment itself.

Gives a Representational Figure of Return

It essentially represents the cumulative percentage of return that a series of gains or losses has on the original principal invested. Investors consider compound return to be a more accurate gauge of an investment’s return over several years because of how volatility plays as a factor.

CAGR is not actually a true rate of return on an annual basis. It is a number that represents the gains and losses during the period of time one holds an investment. 

While past performance is not indicative of future returns, knowing the historical CAGR of a particular mutual fund, ETF, index can be useful. Let us use the below example.

The S&P 500 has an average annual return of 8%(CAGR). The truth is the S&P might return 28% one year and then -2% the following fiscal year. Since inception, the math on the average annual return has come to be about 8% adjusted for inflation.

– A young investor has chosen to make a $5,000 investment into a S&P 500 Index Fund.

– The average annual return remains at 8% with market volatility over five years.

Math:

• Year 1: $5,000 x 8%= $5,400
• Year 2: $5,400 x 8%= $5,832
• Year 3: $5,832 x 8%= $6,298.56
• Year 4: $6,298 x 8%= $6,802.44
• Year 5: $6,802 x 8%= $7,346.64 

There is a reason why Warren Buffet calls compounding returns one of the great wonders of the investment world.