What Does CAGR Mean?
CAGR stands for “Compound Annual Growth Rate”. It’s a way to measure how fast an investment has grown over time. Imagine you have a tree that grows a little bit every year. CAGR helps us see how much the tree has grown on average each year, even if its growth was not the same every time.
How is CAGR Calculated?
The formula looks like this:
CAGR = ((Final Value / Initial Value) ^ (1 / Number of Years)) - 1
Does that seem complicated? Let’s explain it with a simple example!
Easy Example
Let’s say you received 100 dollars for your birthday and decided to put them in a magical piggy bank where the money grows every year.
After 3 years, you check and find 160 dollars inside. Now, we want to find out how much the amount has grown each year.
Using the formula:
CAGR = (160 / 100) ^ (1 / 3) - 1
CAGR ≈ (1.6) ^ (0.333) - 1
CAGR ≈ 1.17 - 1
CAGR ≈ 0.17 (or 17%)
This means your money grew by an average of 17% per year.
Why is CAGR Useful?
CAGR is used to:
- Compare different investments. If you have two ways to save money, CAGR tells you which one grew faster.
- Check if a business is growing well. For example, if a toy store sells more toys each year, CAGR helps measure its growth rate.
Another Example: How Many Apples Do You Have?
Imagine you have an apple tree, and each year it produces more apples:
- In the first year, it grows 10 apples.
- In the second year, it grows 15 apples.
- In the third year, it grows 25 apples.
We can use CAGR to find out how quickly the apple production is increasing!
Limitations of CAGR
CAGR is useful, but it doesn’t tell the whole story. For example:
- If an investment grows a lot in one year but shrinks in another, CAGR only shows the average and doesn’t reflect the ups and downs.
- It doesn’t consider times when you add or remove money from an investment.
Conclusion
CAGR is a great tool for understanding how fast something grows over time. You can use it for money, businesses, or even to track how many apples your tree produces! So next time someone talks about growth, you’ll already know what CAGR means! 🚀
