How to Calculate the Compound Growth Rate

Compound annual growth rate, often shown as CAGR, is used to measure the rate of return of an investment. It is most useful as a way to measure an investment's performance over time, as it takes into account both the time value of money and the initial investment. The compound annual growth rate is a good calculation for novice investors to learn how to use because it smooths out any large changes in profit or loss over the years and leaves you with an average annual rate of return that is simple to understand. Here is how to calculate CAGR.

Instructions

Difficulty: Moderate

Things You’ll Need:

• Calculator

1. Gather your data. To calculate the compound annual growth rate, you will need to know what your initial investment was, what the value of your investment is now and how many years you've held the investment.
2. Plug your data into the following formula: CAGR=((last year/first year)^(1/n-1))-1. In this case, last year is simply the current value of your investment, while first year is the amount your originally invested. "N" is the number of years you have held your investment, and the "^" symbol represents an exponent, meaning "to the power of."
3. Interpret your results. The value you get after calculating your compound annual growth rate gives you a picture of an investment's return over time. However, the investment's return could have varied wildly over the years, and it is only by calculating the CAGR that you end up with an average rate of return.
4. Use this example if you need more help with the formula. If I invested $2,000 ten years ago, and my investment is currently worth $5,000, the compound annual growth rate of my investment is 9.6%. This does not mean I earned 9.6% every year. It could mean my investment gained 40% in its first year, then lost 5% in year two, then varied over the next eight years. CAGR gives a smoothed out picture of rate of return.
5. If the formula is too complicated, use an online calculator specifically designed to calculate compound annual growth rate. One such calculator can be found in the Resources section of this article.

Tips & Warnings

• Don't be afraid to use the formula and calculate CAGR yourself. The formula looks intimidating, but can be worked through pretty quickly if you have all your data available.