What is CAGR? Understanding Compound Annual Growth Rate with a Simple Example

CAGR – Compound Annual Growth Rate – is one of the most commonly used measures for understanding the growth of an investment over a period of time.

You may have seen CAGR mentioned in mutual fund statements, investment reports or financial discussions. But what does it actually mean?

A simple illustration

Suppose you invest ₹5 lakh as a lump sum.

After five years, the value of your investment becomes ₹8 lakh.

The investment has therefore increased by ₹3 lakh during the five-year period.

But simply looking at the total gain does not tell us the equivalent annual rate at which the investment grew on a compounded basis.

For this investment, the CAGR is 9.86% per year.

This means that ₹5 lakh growing to ₹8 lakh over five years represents an equivalent annual compounded growth rate of 9.86%.

Why is CAGR useful?

CAGR is particularly useful when we want to evaluate the growth of a lump-sum investment over a period of time.

It gives us a common annualised measure that can help us understand and compare investment growth over different periods.

However, there is an important limitation.

What happens when money is invested or withdrawn at different times?

Suppose you invest additional amounts at different dates, or withdraw some money from the investment during the period.

In such situations, simply looking at CAGR may not adequately represent the investor's actual experience because the timing of each cash flow matters.

This is where XIRR becomes important.

XIRR takes into account the dates and amounts of investments and withdrawals and therefore becomes particularly useful when there are multiple cash flows occurring at different points in time.

We will explain XIRR with a practical illustration in the next episode of Finance Beyond Numbers.

Watch the video

Finance Beyond Numbers – Episode 4: What is CAGR?

YouTube Link - https://youtube.com/shorts/Ek40VQRhFhE?si=hb-6an1K1ARzR25L

Comments

Post a Comment

Popular posts from this blog

Image
  Blog 4: The Quiet Cost of Acting Too Soon An observation on decisions we rarely question There is a certain comfort in taking action. Doing something—buying, investing, switching—gives a sense of control. It feels as though progress is being made. But over the years, I have noticed a quieter pattern. Many financial outcomes are not affected by wrong decisions… but by unnecessary decisions taken too soon. A Small Reflection I once observed two individuals who began their investment journey around the same time. One was highly active—constantly reviewing, adjusting, and responding to every movement. Each decision was taken with intent, but often in reaction to the moment. The other was far less active. Not indifferent—but measured. He allowed his decisions to settle before revisiting them. Years later, the difference was not dramatic—but it was visible. • One had many decisions behind him • The other had fewer, but more stable outcomes It was not about intelligence. It was abou...
Read more
Image
  BLOG POST 1 Introduction A Journey Towards Financial Clarity Opening Quote “In investing, patience is not merely a virtue—it is often the difference between success and regret.” Money is earned with effort, but managing it wisely often proves far more challenging. Over a professional journey spanning more than four decades—both in India and abroad—I have had the privilege of working with multinational organisations as well as leading Indian corporates in the fields of investments, insurance, and financial advisory. During these years I have seen financial markets behave in fascinating ways. Prices rise with enthusiasm, fall with anxiety, and occasionally move in directions that leave even experienced observers quietly puzzled. Yet one reality has remained constant. Many hardworking and intelligent people struggle not because they fail to earn money, but because they do not always receive clear and practical guidance on how to manage it wisely. This blog is a sma...
Read more
Image
  BLOG POST 2 Why Intelligent People Still Make Poor Investment Decisions “In investing, patience is not merely a virtue—it is often the difference between success and regret.” Financial markets present one of the most interesting paradoxes in human behaviour: intelligent people sometimes make remarkably impulsive investment decisions. Over many years in the financial world, I have observed that investment success is rarely determined by intelligence alone. It is influenced far more by temperament—by patience, discipline, and the ability to remain calm when markets behave unpredictably. Many professionals—engineers, doctors, executives and entrepreneurs—approach their careers with careful planning and discipline. Yet when it comes to investing, the same individuals occasionally find themselves influenced by excitement, rumours, or fashionable market trends. Three behaviours appear repeatedly among investors. 1. Following the Crowd When an investment suddenly becomes the fav...
Read more