What is CAGR? – Definition, Characteristics, Advantages, and More
The compound annual growth rate is a business and investing specific term for the geometric progression ratio that provides a constant rate of return over the period.
The compound annual growth rate (or CAGR for its acronym in English Compound Annual Growth Rate) allows us to know the rate of return that a particular investment reaches during a specific period (which is usually greater than one year, being able to reach three, or even ten). This investment can variable or fixed income.
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Characteristics of the Compound Annual Growth Rate (TCAC)
The main advantage of this indicator is that we can measure the return on investment by mitigating or resolving the volatility in the markets. The estimate made by the index gets based on situations without significant changes in a linear fashion.
To calculate the CAGR, we usually use the value of a specific financial asset in a year and also use the same asset after a particular time we want to determine.
The appellation of “compound,” is because it takes into account the revaluation of the first year for the calculation of the reassessment of the second year and after that.
Advantages of CAGR
This operation 2020-02-04will allow us to know the average of that investment, and if it has been positive or negative and thus know whether or not we have to maintain a particular investment.
However, we must bear in mind that what the rate indicates is only a suggestion, since we are calculating a result based on an estimate. It is due to the instability of certain seasons that occur at a specific time.
For this reason, this indicator becomes a valid indicator. Although we must complement it with other more complex signs that have different types of variables. And observe whether we should continue with said investment or not. You have to be prepared for what might happen. Although this indicator can be a good first approximation of how the analyzed investment behaves.
CAGR: what it is and what it is for
What these acronyms mean and what they entail. Well, the compound annual growth rate serves to know the rate of return of an investment in a specific period. But always for more than one year. It can be three years, five or ten years, and the investment can be fixed or variable income.
The most relevant aspect of this indicator is that it allows measuring that return on investment in a smoother way. That is, mitigating the volatility that usually exists in the markets. We base the estimate on a situation without significant changes in a linear fashion.
Its calculation is quite simple because it is enough to take the value of an asset in a given year and take the same asset after the time we determine. Thus, divide the final cost by the initial value. Rise the result, the first power divided by the number of years that have passed. And, finally, subtract one from the result.
For example, if the initial value is 10,000 euros and the final, after three years, 20,000 euros, we would have the CAGR is:
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