The CAGR is the yearly smoothened growth rate of an investment after a given interval. This is different from the average annual growth rate that investment might have seen over the two years. E.g.:
An investment of ₹1,000 is made in 2014, which then grew 200% in the first year to ₹3,000 in 2015, but then corrected to ₹1,500 in the second year.
In this case, the average annual growth rate would be 75%, which is the average of 200% growth in the first year and a 50% contraction in the second.
However, a 75% annual growth rate would have yielded a return of ₹3,062.5 at the end of the second year, which is not what happened.
To arrive at a more realistic growth rate to explain what happened, the compound annual growth rate, which basically smoothes out the average growth per year over the period under consideration.
So, in this example, the CAGR would be 22.47%. This number shows how much ₹1,000 would have to grow every year to reach ₹1,500 by the end of the second year.
Calculating CAGR requires three pieces of information: the start value of the investment, end value, and the number of periods under consideration.
CAGR provides a more accurate rate of growth that can help investors arrive at a more informed decision about their investment.
However, CAGR does not reflect investment risk. It does not provide information about how the investment has performed within that time period.
