Annual Return Rate (CAGR) — What It Is and How to Calculate It
CAGR (Compound Annual Growth Rate) is the average annual return rate accounting for compound interest. Learn how to calculate it and why it's better than simple average.
Definition
CAGR (Compound Annual Growth Rate), or average annual return rate, is an indicator showing by what percentage annually an investment grew, accounting for compound interest effect. It's the most honest way to compare investment performance over different time periods.
Formula
CAGR = (Final value ÷ Initial value)^(1/n) – 1
Where n = number of years.
Example
You invested 10,000 PLN, after 5 years you have 16,105 PLN:
CAGR = (16,105 ÷ 10,000)^(1/5) – 1 = 0.10 = 10%
Your investment grew on average 10% annually (accounting for compound interest).
CAGR vs. simple average
Simple arithmetic average can be misleading:
| Year | Return |
|---|---|
| 1 | +50% |
| 2 | -33% |
Arithmetic average: (50% + (-33%)) ÷ 2 = 8.5% Actual result: 10,000 → 15,000 → 10,050 → CAGR ≈ 0.25%
The arithmetic average suggests great performance, while CAGR shows the truth — the investment barely earned anything.
Typical CAGR values
| Asset | Historical CAGR (approximate) |
|---|---|
| S&P 500 (1970–2024) | ~10% (before inflation) |
| WIG20 (2000–2024) | ~3–5% |
| Polish treasury bonds | ~4–6% |
| Savings account | ~2–4% |
| Inflation in Poland | ~3–4% (long-term) |
What is CAGR used for?
- Comparing investments — "this ETF gave 8% CAGR, that one 6%"
- Portfolio performance assessment — is your portfolio growing faster than inflation?
- Financial planning — "if my portfolio's CAGR is 7%, in how many years will I achieve FIRE?"
- Realism — CAGR doesn't hide bad years like arithmetic average does
Limitations
- Doesn't show volatility — two investments with 8% CAGR can have completely different risk
- Assumes constant growth rate — in reality, returns fluctuate year to year
- Past ≠ future — historical CAGR doesn't guarantee future results
How Freenance can help
Freenance automatically calculates CAGR of your portfolio and individual positions. You see how your investments perform over time — not just in absolute numbers, but in real annual return rate.
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