CAGR (Compound Annual Growth Rate) is the single most useful number for comparing investment performance. It smooths out year-to-year volatility to show the steady annual return that would produce the same final result.
The CAGR Formula
CAGR = (Ending Value / Beginning Value)^(1/Years) − 1
Example: Portfolio grew from £10,000 to £16,500 in 5 years. CAGR = (16,500 ÷ 10,000)^(1/5) − 1 = 1.65^0.2 − 1 = 1.1052 − 1 = 10.52% per year.
Why CAGR Is Better Than Average Annual Return
The arithmetic mean (average) of annual returns overstates actual performance when there is volatility. Example: Year 1 +50%, Year 2 −33%. Arithmetic average = (+50 + −33) ÷ 2 = 8.5%. But £1,000 grows to £1,500, then falls to £1,005 — a CAGR of 0.25%. The arithmetic average made it look like you gained 8.5%, but you essentially broke even.
Benchmark CAGRs to Know
- S&P 500 (US stocks): ~10.5% nominal CAGR over 100 years; ~7.5% after inflation
- FTSE All-Share (UK): ~8% nominal CAGR over 40 years including dividends
- ASX 200 (Australia): ~9–10% nominal CAGR including dividends
- Global bonds: ~3–5% nominal CAGR
- Cash/savings: ~1–4% (varies with central bank rates)
Using CAGR to Set Realistic Expectations
Past CAGR does not guarantee future returns, but it informs reasonable planning assumptions. Most financial planners use 5–7% real (inflation-adjusted) CAGR for a diversified equity portfolio in long-term projections. A 10% nominal CAGR assumption is often considered optimistic for future decades.
CAGR vs IRR
CAGR works best for lump-sum investments. IRR (Internal Rate of Return) is more appropriate when cash flows occur at irregular intervals — such as adding money monthly or receiving dividends. Most investment apps show both. For regular monthly contributions, IRR or XIRR (in Excel) gives the most accurate picture.
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