If you need to evaluate the performance of investments or financial growth over time, only looking at year-on-year returns may not provide the complete picture. That’s where a CAGR calculator might come in handy. It simplifies calculating the average rate at which an investment grows annually, including compounding effects, providing a clearer view of overall growth over the investment period.
This powerful tool empowers you to assess growth and helps investors and businesses make smarter decisions over a set period, whether tracking metrics like the IRFC share price or SBI share price. This article will further delve into what a CAGR calculator is and how to use it for better financial insights.
To understand the CAGR Calculator, let us first know what CAGR is.
What Is the Compound Annual Growth Rate (CAGR)?
The compound annual growth rate is the annual growth of an investment over a specified duration. The value of the investment is expected to grow every year from its beginning balance to its ending balance in a given time interval. The CAGR considers that any profits were reinvested at the end of each period of the investment’s life span. CAGR shows you how much your investment has earned each year for a given time interval.
What is a CAGR Calculator?
The Compound Annual Growth Rate (CAGR) calculator is a practical tool to measure the compound annual growth rate of your investment over some time. To calculate the CAGR, you need to enter the value of the initial investment, the expected final value of the investment, and the number of years. There is a formula slot in the CAGR calculator where you have to select the beginning and ending value of the investment and the number of years of the investment. The annual rate of growth of your investment will be shown in the calculator. CAGR can also be used to compare. the return on investment against a reference point.
How to calculate compound annual growth rate (CAGR)?
The formula used to calculate CAGR is ((BV/EV)1/n −1)×100
where:
EV = Ending value
BV = Beginning value
Value N = Number of years
To calculate the CAGR of an investment:
- You have to divide the value of an investment at the end of the duration by its value at the beginning of that period.
- Raise the result to an exponent of one divided by the number of years.
- Subtract one from the subsequent result.
- Multiply by 100 to change the answer into a percentage.
The CAGR formula gives an annualised rate of return, which is used for comparing the performance of different investments over time.
Here are some examples of how to use CAGR
Suppose you invested $10,000 in a portfolio with the returns outlined below:
- From Jan. 1, 2018, to Jan. 1, 2019, your portfolio grew to $13,000 (or 30% in year one).
- On Jan. 1, 2020, the portfolio was $14,000 (or 7.69% from January 2019 to January 2020).
- On Jan. 1, 2021, the portfolio ended with $19,000 (or 35.71% from January 2020 to January 2021).
It can be seen that on an annual basis, the year-to-year growth rates of the investment portfolio were quite different as shown above. Conversely, the compound annual growth rate shows the investment’s performance and ignores the fact that 2018 and 2020 were quite different from 2019. The CAGR over that period was 23.86% and can be calculated as follows:
CAGR=($19,000/$10,000)13−1×100=23.86% (Source – Investopedia)
The CAGR of 23.86% as in the above example over the three-year investment period, can be used by investors to compare alternatives for their capital or make speculations of future values. So in any given year, during the period, we see one investment rising while the other falls. This is also applicable when comparing profitable bonds to stocks. So by using CAGR, it would smooth out the annual return over the duration so the two alternatives shall be easier to compare.
Since CAGR applies to stocks, let us see an example. If you want to analyse the performance of a stock, for example, the IRFC share price over the last few years, just looking at price fluctuations shall not provide a complete picture of its growth. A CAGR Calculator will help determine the average annual growth rate of the stock, factoring in the power of compounding. By using the CAGR formula, investors can better comprehend the consistent return on their investment in IRFC or any other stock over a specific period. So, this shows how a CAGR calculator can be applied in real-world stock analysis.
How do investors use the CAGR to decide on potential stocks?
Investors can evaluate other methods to assess past returns or predict future profits once they understand the formula used to calculate CAGR. When investors evaluate potential stocks to buy today, it is crucial to understand their long-term growth potential.
Investors can estimate the average annual growth rate of a stock over time with the help of a CAGR calculator and this would help them make informed decisions. So if you’re considering
a stock for its current performance or its past growth, CAGR shall offer a clearer picture of how an investment could grow, guiding you in selecting the right stocks for your portfolio.
Are there any limitations of CAGR calculators?
While CAGR is a useful concept, it has some limitations. The following are some of the flaws of CAGR calculators:
- In CAGR calculations, only the beginning and ending values are taken into consideration. The calculation supposes that growth is constant over the duration of time and does not consider the aspect of fluctuations.
- A CAGR calculator is suitable only for a total amount of investment. For SIP investments, the systematic investment at several time intervals is not considered. Only the beginning value is taken into account for the calculation of CAGR.
- The CAGR calculator does not factor in the inherent risk of an investment. When it comes to equity investment, risk-adjusted returns are more important than CAGR.
Conclusion
A CAGR Calculator is a useful tool for understanding the steady growth of an investment over time. Investors can evaluate past performance, compare different investment options, and make financial decisions by using this CAGR calculator.CAGR provides a clear, simple way to measure long-term growth and plan for the future whether you’re analysing stock returns, business growth, or portfolio performance.
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