What is CAGR and what are its advantages?

 

What is CAGR and what are its advantages?

CAGR stands for the Compound Annual Growth Rate. It is simply a measure of an investment annual growth rate over time, with the effect of compounding taken into account. It is often used at the time to measure and compare the past performance of investments or to project their expected future returns. The CAGR formulae are equal to the (ending value/beginning value) ^ (1/# of periods) – 1.


CAGR Formula

The CAGR (Compound Annual Growth Rate) formula requires only the ending value of the investment, the beginning value, and the number of compounding years to calculate. It is achieved by dividing the ending value by the beginning value and raising that figure to the inverse number of years before subtracting it by one.

The CAGR formula is as follows:

Where:

EV: Ending Value

BV: Beginning Value

N: Number of Compounding Periods

Characteristics of the Compound Annual Growth Rate

The main advantage of this indicator is that we can measure the return on investment by mitigating or resolving the volatility in the markets. The estimate made by the index gets based on situations without even significant changes in a linear fashion.

To calculate the CAGR, we usually use the value of a specific financial asset in a year and also use the same asset after a particular time we want to determine.

The appellation of the compound is because it takes into account the revaluation of the first year for the calculation of the reassessment of the second year and after that.

Advantages of CAGR

This operation 2020-03-15 will allow us to know the average of that investment and if it has been positive or negative and thus know whether or not we have to maintain a particular investment.

Moreover, we must also bear in mind that what the rate indicates is only a suggestion since we are calculating a result, which is based on an estimate. It is mainly due to the instability of certain seasons that occur at a specific time.

For this sort of reason, this indicator becomes a valid indicator. Although we must complement it with some other more complex signs that have different types of variables and even observe whether we should continue with said investment or not. You have to be much prepared for what might happen, although this indicator can be a good approximation of how the analyzed investment behaves.

Also Read: What Are Mutual Funds?

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