ReviewedEducational article · Updated Oct 2026
Key takeaways
- CAGR is the steady annual rate that gets you from start value to end value.
- A simple average of yearly returns can mislead when returns bounce around.
- Volatility usually makes CAGR lower than the arithmetic average.
- Use CAGR to compare multi-year paths on a like-for-like basis.
People often quote an “average return.” There are different averages, and they answer different questions. CAGR — compound annual growth rate — answers a specific one: what single annual rate, compounded, takes me from the starting value to the ending value over this period?
A classic trap
Suppose an investment goes from $100 to $150 in year 1 (+50%), then back to $100 in year 2 (−33.3%). The simple average of +50% and −33.3% is about +8.3%. But you ended where you started — the true compound annual growth is 0%.
CAGR for a path that finishes at the same value it started — even if the yearly average looks positive.
Arithmetic averages describe the ride. CAGR describes where you got off.
The CAGR formula
CAGR = (Ending / Beginning)1/n − 1
where n is the number of years. Percentage change over the whole period is simply (Ending − Beginning) / Beginning. CAGR annualises that multi-year change.
Why volatility hurts the compound rate
When returns vary, the compound growth rate is generally lower than the arithmetic mean of yearly returns. That gap is sometimes called volatility drag. It does not mean volatility is “bad” in every context — it means you should not confuse a simple average with the growth rate your balance actually experienced.
Teaching use: CAGR is ideal for comparing two completed paths over the same horizon. It is not a promise about next year’s return.
What the model leaves out
Deposits and withdrawals complicate return measurement (time-weighted vs. money-weighted returns). A basic CAGR tool assumes a start value and an end value with no mid-stream cash flows — clean for education, incomplete for a funded account with monthly contributions.
This article is for general educational purposes only and is not financial advice. Examples use simplified, hypothetical numbers and ignore taxes, fees and personal circumstances. Consider speaking with a qualified professional before making financial decisions. See our full disclaimer.