How to Calculate CAGR
For any person who has invested money it is essential he/she evaluates his/her investment performance. For that it is important to calculate the total return and CAGR or compound annual growth rate. The method of calculation and the concept of CAGR has been discussed in the following article.
The CAGR is applicable for fixed return investments such as fixed annuities and certain fixed insured policies where return amount is assured. The CAGR formula is, however, not applicable for investments that tend to have a floating returns structure. In a floating returns structure the CAGR formula is usually not applicable as the portfolio performance is governed as per market conditions. There are, however, instances where the CAGR formula and final percentage rate is taken into consideration in order to analyze and assess the said investment. Essentially, a CAGR is a percentage value that is used to derive the return on investment over a period of time, on an annualized basis. The formula quite simple and the following is the practical application of the CAGR...
Formula to Calculate CAGR
The formula for CAGR takes into consideration three important values or dimensions of a specified investment, namely, the ending value of the investment, the beginning value of the investment and time period for which the investment has been made. The end result of this very formula is a rate (expressed in percentage) that gives us the return on investment that we receive per year.
The formula goes as follows:
CAGR = {(Ending value / Beginning value)(1 / no. of years)} (- 1)
The formula will give you a percentage rate that is applicable for every year that is it is applicable in an annualized manner. One can calculate the CAGR in several different manner, a calculation for simple CAGR on a plain paper is a simple deal. However, in the corporate world, or in cases where the investment denomination is large, the need to calculate CAGR online is felt. Often people tend to ask the query, 'how to calculate CAGR in excel'. The entire process is fairly easy. First write the initially invested amount in a negative form, next go on writing down the accumulation of returns in the successive cells. In the last cell, apply the =XIRR(A2:A6,B2:B6) formula. You will product of successive decimals, which you will have to convert into percentage.
Application of the CAGR in Real Life
The CAGR rate is applicable in several circumstances where the three perquisite dimensions that is the ending value, beginning value and number of years is available. Though, in theory the formula is applicable for fixed return investments, you can use the same to analyze, summarize and forecast the return value of investments on an annual basis, thus right from stock investments to mutual funds and index funds, the CAGR can be used as a tool of analysis. There are two potential ways in which we can apply the CAGR, that is in the pre-investment time, when you are planning to invest into a said channel and want to derive the rate of return for a year. In such a case if the investment is a fixed return investment then the CAGR points out to what your return will be in the coming years. If the investment gives a variable return, then the formula can be used to predict the returns. In such circumstances where the portfolio determines the returns, the CAGR percentage value is the ideal rate of return that one might receive, the product in such a situation is more of a guideline. In several cases the CAGR is used post the investment to derive, how much you have actually earned also at what rate.
Thus the formula is a very good financial tool as well as a good financial planning and financial management formula that helps us to derive the best of the best investments. The concept though not an accounting concept but can be used by you for multiple purposes.
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