Compound Annual Growth Rate is the cleanest way to compare investment performance over time. Here's the formula, worked examples, and why it beats simple averages for financial decisions.
You invested £10,000 five years ago and it's now worth £16,000. What was your annual return? The answer isn't as simple as dividing the gain by the years — you need CAGR.
Compound Annual Growth Rate (CAGR) is the rate at which an investment would have grown if it grew at a perfectly steady rate each year. It smooths out volatility to give you a single, comparable annual figure.
This is where most people go wrong. If an investment gains 50% one year and loses 33% the next, the arithmetic average return is +8.5% per year — but you've actually broken even.
The CAGR of 0.25% is an accurate picture of reality. The arithmetic average of 8.5% is meaningless for understanding actual returns.
Fund A has the biggest headline gain but the worst CAGR. Fund C has the highest annual return. Without CAGR, comparing these would be guesswork.
It ignores volatility. Two investments with identical CAGRs can have completely different risk profiles — one might have been smooth and steady, the other wildly volatile with the same start and end points. CAGR tells you nothing about the journey.
The start and end points matter enormously. CAGR is very sensitive to what date you pick. An investment measured from a market peak will show a lower CAGR than the same investment measured from a trough. Always check what period is being used.
It assumes reinvestment. CAGR reflects compound growth, which assumes all gains are reinvested. If dividends were taken as income rather than reinvested, the actual portfolio growth will differ.
CAGR isn't just for investments. It's widely used for any growing metric: revenue, customer base, market size. A company that grew revenue from £2M to £5M over 4 years has a CAGR of:
This gives a much cleaner picture than saying "revenue grew 150% in 4 years" or averaging four separate annual growth rates.