Investment returns are often quoted as an average, but your money grows at the compound rate. The difference can be large.
The trap
$10,000 gains 50% in year one ($15,000), then loses 30% in year two ($10,500).
- Average return: (50% − 30%) / 2 = 10% a year.
- What actually happened: $10,000 became $10,500, about 2.5% a year.
A simpler version: +20% then −20% is not break-even. $10,000 becomes $12,000, then $9,600.
CAGR: the honest number
Compound annual growth rate (CAGR) is the steady yearly rate that turns the starting value into the ending value:
CAGR = (ending value / starting value)^(1 / years) − 1
Example: $10,000 grows to $25,000 over 7 years. (25,000 / 10,000)^(1/7) − 1 = about 14.0% a year.
Where this matters
- Comparing funds: compare CAGR (often called annualized return) over the same period, not average yearly returns.
- Your own portfolio: if you added money along the way, CAGR on the start and end values overstates your return; a money-weighted return (XIRR in a spreadsheet) handles deposits correctly.
- Volatility drag: two investments with the same average return end up in different places; the more volatile one usually ends lower.
Spreadsheet formulas
- CAGR: =(B2/A2)^(1/C2)-1, with start value in A2, end value in B2 and years in C2.
- With deposits and withdrawals: =XIRR(amounts, dates), entering deposits as negative amounts and the current value as a positive amount on today's date.
Free tools
- CAGR calculator: https://smartbudgetsheets.surge.sh/calculators/cagr-calculator/?utm_source=mataroa
- Investment calculator: https://smartbudgetsheets.surge.sh/calculators/investment-calculator/?utm_source=mataroa
- ROI calculator: https://smartbudgetsheets.surge.sh/calculators/roi-calculator/?utm_source=mataroa
- Debt Payoff Planner, up to 8 debts (Payhip): https://payhip.com/b/PtBLU?utm_source=mataroa
- 42 free budget templates, pay what you want ($0 is fine): https://smartbudgetsheet.gumroad.com/l/ngpkrb?utm_source=mataroa
General information, not financial advice. Figures are rounded examples.