How does CAGR work?

To measure your annual growth, often the CAGR calculation method is getting used. But how does it exactly works? CAGR stands for Compound Annual Growth Rate. This calculates the average compounded return over a specific period. For example, to see what return is needed on average per year to arrive at a certain value.

Example

Suppose you invest $10,000 in stocks whose growth has been variable over the past four years:

If you would take the average return by dividing it with each other, you would end up with a positive return of +3.75% per year. While you have made a loss on your ending value.

(20% + 30% − 40% + 5%) / 4 = 3.75%

Using CAGR will give you a more accurate picture of the average return. For example, with a CAGR calculation you will end up with a return of -0.43% per year.

(ending value / starting value) ^ (1 / number of years) - 1
($9,828 / $10,000) ^ (1 / 4) - 1 = -0.43%

Because the CAGR calculation includes compound growth, which means that the interest-on-interest effect has been included, the positive and negative years are better taken into account.

Absolute vs MWRR CAGR

Within PDT we have made it possible to choose how your return is calculated. This also affects the CAGR calculation. The absolute CAGR will be calculated as in the example above. But once the MWRR calculation has been set, we approach determining your final value differently. Your deposits are weighted over your investment period, which also affects your final value. Read more how your MWRR is calculated.

MWRR CAGR = (Total MWRR) ^ (1 / number of years) - 1
Absolute CAGR = (Absolute MWRR) ^ (1 / number of years) - 1

When do you use CAGR?

If you invest for more than a year, it could be useful to view the CAGR of your portfolio. For example, if you invest for 6 years and you have a total return of 103%, leave that much to your imagination. Maybe a CAGR of 9.38% gives you more insights. So you can compare it as well to (the long-term average of) the market or other shared portfolios.