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Showing posts with label CAGR. Show all posts
Showing posts with label CAGR. Show all posts

Wednesday, November 11, 2020

How to Calculate CAGR of your Investments?

Dear Reader,

This article will let you know how to calculate the compound annual growth rate, or CAGR, in Excel. You’ll also learn about some of the limitations.

Note: You can download our excel file to calculate CAGR returns, click on download link available at bottom of the article.

Different investments go up or down in value by different amounts over different time periods. Investors need a method of comparing one investment against another, especially if the returns have been volatile, or if investments and withdrawals are at irregular dates.

CAGR is the annual return of an investment assuming it has grown at the same rate every year. It’s a common concept; for example, the one, three and five-year returns on mutual fund fact sheets are CAGR values.

One method of calculating CAGR is given by this equation.

 There are three parameters in this equation.
  • start value of the investment
  • end value of the investment
  • number of years between the start and end value
You can also manipulate this formula to give, for example, the number of years required to grow an initial investment from a start value to an end value, given the growth rate..

Below tables use the above formulas to calculate CAGR.


You can also rearranges the formula so you can calculate the final amount (given the initial amount, CAGR, and number of years) and the number of years (given the initial and final amount, and CAGR).

You can also calculate the Compound Annual Growth Rate using Excel’s XIRR function – check out the screen below for an example.
 

XIRR takes three arguments:
  • The first is a range of cash flows into or out of the investment. Invested amounts are positive, but withdrawals are negative.
  • The second is a range of dates corresponding to the investments or withdrawals,
  • The third is a guess value for the CAGR (XIRR uses Newton-Raphson iteration, so it needs a guess value tostart the iteration).
XIRR is flexible, and can also given you the CAGR given investments and withdrawals at irregular dates. As an example, examine the screen of the Excel spreadsheet.

CAGR has some limitations that investors need to be aware of:
  • CAGR hides volatility by assuming that investments grow at a constant rate. Volatility is an important factor in managing investment risk and can’t be ignored.
  • It’s based on historical data, and can’t be relied on as the only method of predicting future value.
  • CAGR can be manipulated by picking the time period over which it is measured. An unscrupulous fund manager can, for example, choose a start date with an unusually low investment value.
You can download our excel file which contains examples demonstrated in this article and can use the same to find out CAGR of your investments.

CAGR Calculator excel file - Download

Note: You’ll need to enable the Analysis Toolpack to use the XIRR function.

Regards,
Team - Saral Gyan

Friday, September 24, 2010

How to Calculate & Evaluate CAGR?

CAGR stands for “Compound Annual Growth Rate”

It is the growth rate of a company expressed on an annualized basis. This also takes into consideration the effect of compounding. Let’s look at an example to understand it better.

Say the sales of a company 4 years back was 100. Today, after 4 years, it is 200. A simple conclusion is that sales has increases by 100% in 4 years. But does it mean that it has increased by 25% each year?

That would not be correct, as simply dividing 100% by 4 doesn’t take into consideration the compounding effect.

So, to find out the per year growth rate of a company, we use the compound interest formula.

A = P * ( ( 1 + r ) ^ n )

Where

A = Final Amount
P = Principal amount
r = Rate of interest, expressed in %
n = Number of years

In our example,

A = 200
P = 100
r = The annual growth rate (that we want to find out)
n = 4 years

From the above formula, we find out that r is around 19%.


How to interpret?

It means that the average growth of the company over these 4 years, taking into account the impact of compounding, is 19%.

In the first year, the company grew from 100 to 119. In the second year, it grew 119 to 142. In the third year, it grew by 19% from 142 to 168.5, and in the fourth year, it grew from 168.5 to 200.

Other Thoughts

This principle is very important to understand, because it is used at many places.

For example, it is looked at while examining at returns generated by mutual funds (MFs). Whenever one sees returns for more than 1 year, they are expressed in terms of CAGR. If they are not expressed in CAGR terms, the returns are not accurate!

CAGR should also be used while considering any investment. Just take the example of the Bhavishya Nirman Bonds issued by NABARD.

These have been issued at around Rs. 9750. The investment is for 10 years, after which the investor gets back Rs. 20000.

Thus, the return is Rs. 20000 – Rs. 9750 = Rs. 10250, or 105% in 10 years.

Does this mean that the return is 10.5% per year?

No! It has to be calculated using the CAGR formula, where:

A = 20000
P = 9250
r = Rate of return to be found out
n = 20 years,

Using the formula above, we find out that the rate is actually 7.5% per annum. Now, that’s quite far from 10.5%.