What CAGR actually measures

Q: What is the difference between CAGR and average annual return?

The average adds the yearly returns and divides by the years. CAGR finds the one steady rate that produces the same end value. Whenever returns vary the average is higher: 7.20% against a CAGR of 5.87% on the example path.

One steady rate that links a start value to an end value. It is honest about the destination and silent about everything in between.

6 minute read

What CAGR actually measures is narrower than most people use it for. The compound annual growth rate is the one steady yearly rate that would turn a start value into an end value over a given number of years. It needs three inputs and nothing else, and the CAGR calculator will give you it in a second. The useful part is knowing what those three inputs leave out.

The sum itself

Divide the end value by the start value, take the root for the number of years, subtract one. Something that went from 100 to 250 over ten years has a CAGR of 9.60%: 100 growing at a steady 9.60% for ten years reaches 250.

Notice what it is not. A 150% gain over ten years is not 15% a year. Dividing the total by the years ignores that each year's growth builds on the last, so it always overstates the yearly rate of a gain.

CAGR vs average annual return

The other tempting shortcut is to average the yearly returns. Take an invented ten-year path, chosen to have some bad years in it:

+20%, +15%, −30%, +25%, +10%, +8%, −12%, +18%, +12%, +6%.

The average of those ten numbers is 7.20%. But 100 run through that path ends at 176.84, and the steady rate that gets there is 5.87%. The average overstates what the money actually did by more than a point a year.

The simplest version of the gap: up 50%, then down 50%. The average is zero. The money went from 100 to 150 to 75, a CAGR of −13.4%. Losses are taken from a larger base than the gains were added to, so the average return always reads at or above the CAGR, and the gap widens the more the years vary. That is also why a CAGR is the right figure to compare with a rate in any growth calculator: those tools compound a steady rate, which is what a CAGR is.

What CAGR hides: the path

A CAGR of 5.87% says nothing about the −30% in year three. A path of ten calm years at 5.87% ends at exactly the same 176.84. The destination is identical; the experience of getting there is not, and if you had needed to take money out after year three the two would have left you in very different places. Returns are not a straight line goes into why that matters most for a pot you are drawing from.

What CAGR hides: where you start and stop

Because only the two end points count, moving either one can change the answer a lot. On the same invented path:

All ten years: 5.87% a year.
Starting after the −30% year, the last seven years: 9.02%.
Starting one year later, after the first +20%: 4.40%.
Just the first two years: 17.47%.

Every one of those is arithmetically correct. When you see a CAGR quoted, the dates it runs between are part of the claim. A period that starts just after a fall will flatter the figure; one that starts just before will do the opposite.

What CAGR hides: money added along the way

This is the mistake that produces the most dramatic wrong numbers. CAGR assumes one amount at the start and nothing added or taken out. Point it at an account you have been paying into and it counts your own deposits as growth.

Put $10,000 in and add $300 a month for twenty years, and suppose it earns a steady 7%. The balance reaches $190,958, of which $82,000 is money paid in. Run a CAGR from $10,000 to $190,958 and you get 15.9% a year — more than double the 7% the money actually earned.

It gets worse. With no return at all, the same deposits leave exactly $82,000. A CAGR from $10,000 to $82,000 says 11.1% a year, for money that earned nothing. For an account with deposits or withdrawals, the figure you want is a return that accounts for the cash flows, which is a different calculation. To see what regular contributions and a steady rate produce together, the compound growth calculator models them month by month.

What CAGR is good for

With those limits in view, it does one job well: it puts two completed periods of different lengths on the same yearly footing. A fund that went from 100 to 180 in seven years and one that went from 100 to 250 in twelve cannot be compared by their totals; their CAGRs, 8.8% and 7.9%, can be. It describes what happened between two dates. It does not say anything about the next one.

Common questions

What is the difference between CAGR and average annual return?

The average adds the yearly returns and divides by the number of years. CAGR finds the one steady rate that produces the same end value. Whenever returns vary, the average is higher: on the invented path above, 7.20% against a CAGR of 5.87%.

Is a higher CAGR always better?

It is higher growth between the two dates chosen, nothing more. It does not show how bumpy the path was, and a different start or end date can change it by several points.

Can I use CAGR on my own investment account?

Only if nothing was added or withdrawn between the two dates. Otherwise it counts deposits as growth: $10,000 plus $300 a month for twenty years, earning nothing, shows a CAGR of 11.1%.

Why is a 150% gain over ten years not 15% a year?

Because growth compounds. 9.60% a year, applied to a growing balance for ten years, is enough to turn 100 into 250. Dividing the total gain by the years ignores the growth on earlier growth.

Does a past CAGR tell me what to expect?

No. It summarises a finished period. The calculators on this site never turn a past CAGR into a forecast; they show what a range of assumed rates would produce instead.

Not financial advice. The ten-year return path is invented to show the arithmetic and does not describe any real market, fund or period. Contribution examples assume a steady return, deposits at the end of each month and no fees.