Calculating investment performance is one of the first things finance students must learn in business school. Along with risk, return is a fundamental concept that is clearly important when dealing with wealth and how to grow it over time. The compound annual growth rate, or CAGR for short, represents one of the most accurate ways to calculate and determine returns for individual assets, investment portfolios and anything that can rise or fall in value over time.
The CAGR represents the year-over-year growth rate of an investment over a specified time period. And as the name implies, it uses compounding to determine the return on the investment, which we will see below is a more accurate measure when those returns are more volatile.
Average Returns Frequently, investment returns are stated in terms of an average. For instance, a mutual fund may report an average annual return of 15% over the past five years made up of the following annualized returns:
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