Knowing how to Calculate Compound Annual Growth Rate (CAGR) is straightforward and can be very informative when analyzing investments over time. Here’s a step-by-step guide along with the formula and a hypothetical example. You will also see a graph to visually represent the investment’s growth.
Steps on how to Calculate CAGR
Step 1 – Identify the Beginning Value (BV) of the Investment: This is the initial amount of money invested or the value of the investment at the start of the period.
Step 2 – Identify the Ending Value (EV) of the Investment: This is the value of the investment at the end of the period.
Step 3 – Determine the Number of Years (n) the Investment was Held: This is the time period over which the investment has grown, typically measured in years.
Step 4 – Apply the Values to the CAGR Formula: The formula for CAGR is:
CAGR = (EV / BV)1/n – 1
The cagr formula above calculates the mean annual growth rate of an investment over a specified time period longer than one year. Now let’s use an example to demonstrate this calculation.
Example on how to Calculate Compound Annual growth Rate
Let’s assume you have an investment with the following details:
- Beginning Value (BV) = $1,000
- Ending Value (EV) = $2,000
- Number of Years (n) = 5
Using the CAGR formula, the Compound Annual Growth Rate for this investment will be approximately 14.87%.
Visual Representation
Let’s visualize this with a graph to better understand how the investment grows over time. This graph will show the value of the investment at the end of each year, assuming it grows at a constant rate.
Understanding the Graph
- The graph shows the value of the investment at the end of each year.
- It assumes a constant growth at the calculated CAGR.
- This helps in visualizing the exponential growth due to compounding.
Conclusion
Knowing how to calculate Compound Annual growth Rate is a useful way to understand the growth of investments over time. It provides a clearer picture than simply looking at the final values, as it takes into account the time value of money.
Using CAGR, investors can compare the performance of different investments over different time periods. You can also read more about “Understanding Compound Annual Growth Rate“.
