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Excel Guide

A Step-by-Step Guide to Calculating Compound Annual Growth Rate (CAGR) in Excel

Compound Annual Growth Rate (CAGR) represents the average annual growth rate of an investment over a period exceeding one year. The calculation involves taking the nth root of the total percentage growth rate. For instance, a 10% annual return compounded over a decade results in a CAGR of 10%.

Exploring CAGR

CAGR serves as a return metric that mitigates the impact of individual year volatility, providing a clearer view of the underlying trend. In contrast to simple annualized returns, which rely on the arithmetic mean of individual returns, CAGR considers the compounding effect over time. This proves especially valuable when comparing investments with varying holding periods. For instance, an investment doubling in value annually yields a 100% CAGR, while its simple annualized return amounts to only 50% (1.0 * 2.0 * 3.0 * 4.0 = 24).

Calculating CAGR:CAGR is determined by taking the nth root of the total percentage growth rate. For instance, a 10% annual return compounded over 10 years results in a CAGR of 10%.

Formula for CAGR:The CAGR formula is:

CAGR = (EV / BV)1 / n - 1

where:

  • EV is the ending value of the investment
  • BV is the beginning value of the investment
  • n is the number of years

Utilizing CAGR

CAGR is employed to assess the performance of various investments, including stocks, mutual funds, and bonds. It proves valuable for comparing the performance of investments with different holding periods. For example, if one stock has a 10% CAGR and another has a 5% CAGR, the former is outperforming the latter.

Advantages of CAGR

CAGR offers several advantages, including its simplicity and ease of understanding, suitability for comparing investments with different holding periods, and its ability to smooth out year-to-year volatility, providing a more accurate representation of the underlying trend.

Disadvantages of CAGR

However, CAGR has its drawbacks, such as being a hypothetical measure that does not mirror actual experience, potential misleading results when comparing investments with different risk profiles, and the challenge of manual calculation.

Calculating CAGR in Excel

To calculate CAGR in Excel, follow these simple steps:

  1. Enter the starting value of the investment in cell A1.
  2. Input the ending value of the investment in cell A2.
  3. Specify the number of years in cell A3.
  4. In cell A4, enter the CAGR formula: =CAGR(A1,A2,A3).
  5. Press Enter to obtain the CAGR calculation.

Conclusion

CAGR proves to be a valuable tool for assessing and comparing investment performance, presenting both advantages and disadvantages. The process of calculating CAGR in Excel is straightforward using the dedicated CAGR function.