CAGR – Explained

CAGR stands for Compound Annual Growth Rate. It basically tells the annual rate at which the investment grew by taking compounding too into consideration. Let us understand it with an example. Imagine a bank personnel contacted you and said if you deposit ₹500,000 today, the bank would give you ₹10,00000 after 8 years. This may sound good to you and you probably said to yourself that let me deposit the money. Now let us calculate the CAGR for the above example and see whether it is worth it,

The formula to calculate CAGR is,

CAGR = { ( Final Amount ÷ Initial Amount ) ^ ( 1 ÷ n ) } – 1

I’m using flower bracket instead of the regular bracket to ensure things look less complicated.

‘^’ refers to exponent. ‘n’ refers to time period (in this case it denotes number of years). So let’s substitute the values in the formula.

CAGR = { ( 10,00,000 ÷ 5,00,000 ) ^ ( 1 ÷ 8 ) } – 1

CAGR = 9.05 %

I calculated this value using scientific calculator. I also verified the answer using online CAGR calculator. One can also use Microsoft Excel to calculate CAGR.

Well, the 9.05 % we got is decent. And it denotes that the above investment is good. Had we got something like 4%, then it was a hint that we should stay away from that investment, and the reason is inflation. Imagine you decided to put the money in bank at a 4% annual return and stayed in a rented house. In India the rent gets increased by 5% every year. Now if you look at the purchasing power, your money is getting increased by 4% every year while your expense is increasing at 5% every year. So that’s a bad investment. Well, if you are a long term reader of this blog you already know that I’m bad at Math, so I wouldn’t be going into too many permutations and combinations. Basically the rate at which your money grows should be greater than inflation. Well, the previous sentence sums up everything.

In the above example we calculated CAGR for bank return, in stock market we calculate CAGR for individual stock, an index etc.

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Disclaimer : Trading stocks is subjected to market risks. Please read all the terms and conditions before investing. The motive of this post was to teach little things about stocks for those who do not understand much about stocks. Candidcanblog.com will not hold any responsibility for any losses incurred to the readers of this post.