Compound Annual Growth Rate (CAGR) measures the mean annual growth rate of an investment over a period longer than one year. It smooths out volatility to give a single representative growth figure.
The CAGR Formula
CAGR = (Ending value ÷ Beginning value)^(1/n) − 1
Where n = number of years
Example: An investment grows from £10,000 to £18,000 over 6 years:
CAGR = (18,000 ÷ 10,000)^(1/6) − 1
CAGR = 1.8^(0.1667) − 1
CAGR = 1.1029 − 1 = 10.29%
Why CAGR Is Useful
Actual year-by-year returns are often volatile. CAGR provides a single, comparable number.
| Year | Return | Portfolio value |
|---|---|---|
| Start | — | £10,000 |
| 1 | +30% | £13,000 |
| 2 | −15% | £11,050 |
| 3 | +22% | £13,481 |
| 4 | +5% | £14,155 |
| 5 | −8% | £13,023 |
| 6 | +38% | £17,972 |
Arithmetic average: (30−15+22+5−8+38)/6 = 12% — misleading
CAGR: (17,972/10,000)^(1/6) − 1 = 10.2% — accurate
The arithmetic average overstates the true compounded return.
CAGR Reference Table
| Scenario | Starting value | Ending value | Years | CAGR |
|---|---|---|---|---|
| S&P 500 (long-run) | £10,000 | £76,000 | 20 | 10.7% |
| Property | £150,000 | £280,000 | 10 | 6.5% |
| Savings account | £10,000 | £12,200 | 5 | 4.0% |
| Business revenue | £1M | £3.5M | 8 | 16.9% |
CAGR vs Absolute Return
| Metric | Formula | Best for |
|---|---|---|
| Absolute return | (End − Start) / Start | Single-period comparison |
| CAGR | (End/Start)^(1/n) − 1 | Multi-year comparison |
| Annualised return | Like CAGR but for sub-year | Less than 12 months |
Projected Future Value Using CAGR
Rearranging the formula:
Future value = Present value × (1 + CAGR)^n
Example: If a business grows at 15% CAGR, what will £2M revenue become in 5 years?
£2M × (1.15)^5 = £2M × 2.011 = £4.02M
Limitations
- CAGR assumes smooth growth — it hides volatility
- Two investments with the same CAGR can have very different risk profiles
- Does not account for cash flows in and out of an investment